Battle of the behemoths

A currency war has started. The United States sparked the war, and its target is China. The was predicted by Chinese economic commentator Lei Sihai two years ago in his book “The Great Decisive Battle: The Imminence of the Sino-U.S. Currency Wars.” In Lei’s scenario, the United States would wage a currency attack from late 2015 by suddenly pushing up the overnight base rate. Shares in Japan, Korea and Southeast Asia would tumble by more than 6 percent. By the time the U.S. stock market opened, over $5 trillion would have been knocked out of the global capital market. A bigger storm would brew in the currency markets. The Japanese yen and euro would lose more than 3 percent. The yuan could tumble to the daily limit.

Lei based his forecast on two previous U.S.-led currency battles. The European economy suffered a recession for five years, Russia for six years, Southeast Asia for eight years and Japan for 15 years as a result. The attack on China could push the world’s second-largest economy into a depression for five to 10 years if the United States wins the battle. He hit the nail with his forecast of a third avenging of the dollar - between late 2015 and 2016. Billionaire currency investor George Soros would lead the campaign. Lei’s ominous warning turned out to be true in some areas.

Another American hedge fund investor, Kyle Bass, has been even more forward. He publicly declared that his fund Hayman Capital Management will bet on a weakening yuan, a trend he predicted to go on for the next three years and end up devaluing the currency by 40 percent. He was specific in his reasoning for shorting yuan assets after studying the fast-expanding debt scale. He claimed his company concluded that about $34 trillion worth of bubbles have built up around the Chinese banking system over the last decade, and about $3.5 trillion in losses would be inevitable in the process of cleaning up the nonperforming assets. The estimated losses would be five times bigger than the $650 million the American banking sector incurred during the 2008 global financial meltdown. The yuan would inevitably skid as China’s banking sector sinks.

Our concern is our own currency. The won is working as a proxy for the Chinese currency because the Korean economy relies so much on China. The won has been swinging heavily along with the yuan. The correlation ratio with the yuan has shot up to 0.87, which means the won is now more or less moving in sync with the yuan. The won has been sliding on bets on devaluation of the yuan. The won’s sharp plunge over the weekend was, in fact, triggered by expected losses in the yuan. The Bank of Korea and Ministry of Strategy and Finance stepped in with verbal intervention, but fell short of reversing the trend.

Investment banks are fanning short sales of the Korean won. Morgan Stanley placed the won on its short sales list, citing the Korean economy’s overreliance on China and external trade, and its high level of household debt. Franklin Templeton last month sold 2 trillion won ($1.6 billion) worth of won-denominated government bonds. Overseas investors were betting on coupling the won with the falling yuan.

The Chinese currency will somehow withstand the attack. Former U.S. Treasury Secretary Lawrence Summers claimed that there is a “balance of terror” - a term borrowed from the nuclear arms race between the United States and Soviet Union during the Cold War - in the financial world as well. If the Chinese economy collapses, the U.S. economy won’t be safe. The world’s two largest economies won’t push the conflict to a mutually destructive endpoint.

At the end of the day, it will be the Korean won that ends up being battered from the battle of the behemoths. Bank of Korea Gov. Lee Ju-yeol last weekend cited a poem to refer to the protracted cold spell over the Korean financial climate. “Spring has arrived, but it does not feel like one,” he said.

To make matters worse, escalated tensions from the North Korean nuclear crisis have aggravated financial woes. We may find ourselves suddenly swept up by a liquidity crisis. But none of this seems to worry our leaders and politicians. An army without alertness cannot defend a nation. In exactly the same way, an economic team without any vigilance cannot defend our national wealth.

JoongAng Ilbo, Feb. 25, Page 30

The author is an editorial writer for the JoongAng Ilbo.

by Yi Jung-jae