Let the market workThe Korean currency broke through 1,000 won against the U.S. dollar yesterday, falling 31.90 won in just one day to close at 1,029.20 won.
The fall in the exchange rate is so steep that before the foreign exchange markets closed, the Bank of Korea spoke up to say that the decrease against the dollar was quite rapid. The recent unsettling change in the exchange rate seems to be the result of multiple factors. Since the beginning of this year, the current account deficit has been growing significantly due to import prices. Amid the liquidity crisis sparked by the U.S. subprime mortgage meltdown and the credit crunch, foreign investors have sold off Korean stocks and exchanged their won for dollars, weakening the won even further.
Two things are worrisome in the current exchange rate. First, the rate is going down too rapidly over a short period of time, and sudden fluctuations in rates benefit nobody but speculators. A weaker won might help Korean exporters but it increases the cost of imported raw materials and then many commodity prices rise as a result. A weaker won also has a negative influence on consumption and investor sentiment, creating sluggish domestic demand. Second, the won’s depreciation is in contrast to other currencies. American investors are selling off securities around the world, but unlike the euro or the yen, only the won is weakening. We wonder if the Korean authorities’ desire to defend the currency has any influence. Finance Minister Kang Man-soo unnecessarily caused misunderstanding by making a remark about “sovereignty over the exchange rate.” Some observers say that currency speculators have already started to bet on the weak won, even as authorities maintain that they will aggressively defend the won.
The central bank used to interfere in the exchange rate in an attempt to lift exports and support the economy but such measures belong to a bygone era. Each economic entity predicts the natural moves of the exchange rate market. Due to painful past experiences, many companies hedge currency risk, so it is best to leave the exchange rate to the market. The authorities seem to have already forgotten that the country fell into a financial crisis because they set an arbitrary exchange rate and stuck to it. The government and the Bank of Korea do not coordinate with each other. The Finance Ministry appears to accept the increase in the rate and days later the Bank of Korea tries to slow down the change. They must not attempt to interfere in the foreign exchange market.