Currency swap cargo cult

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Currency swap cargo cult

Suh Kyoung-ho
The author is an editorial writer at the JoongAng Ilbo.

After World War II, bizarre “cults” emerged among Melanesian islanders in the South Pacific. After experiencing windfalls — airdrops from allied forces of clothing, medicine, food, tents and weapons — the islanders began to mimic the practices of American soldiers parading in their uniforms and performing ground drills with wooden or salvaged rifles. They even built crude flight control towers and landing strips in the jungle in hopes that it would bring back airplanes and rare materials. They thought the aircraft had been sent by the deities or ancestors they believed were the only beings that could have brought about such abundance. Anthropologists called them “cargo cults.”

The talk of a currency swap with the dollar has been building in Korea as if in cult-like enthusiasm. They are acting like the islanders unfamiliar with the outside world, praying that a currency swap with the U.S. could suddenly stabilize the foreign exchange market and solve many other problems magically.

A currency swap with the United States amid the financial turmoil in 2008 indeed worked miracles. As soon as the swap agreement was announced, the Korean currency gained 177 won and the main stock price index jumped 12 percent. Another currency swap in 2020 amid the Covid-19 pandemic also bolstered the Korean currency by 39 won and the stock index 7 percent on the following day of the agreement. A swap with the U.S. dollar has acted to buffer the external shocks along with foreign exchange reserve and credibility in meeting debt obligation.

But many would be unaware of the short-lived halo. In 2008, the value of the won retreated back to 1,250 per dollar less than a month after the agreement. By July 2009, the Korean currency slid to 1,300 won per dollar. A currency swap with the U.S. dollar can have an immediate effect, but does not last. The exchange rate is determined by economic fundamentals.

The market and others are raising expectations for a similar pact when U.S. Treasury Secretary Janet Yellen visits Seoul this week. In a press briefing after a rate hike last week, Bank of Korea Gov. Rhee Chang-yong said that a currency swap can only be decided by the U.S. Federal Reserve upon finding the need for global market stability — instead of being an intergovernmental issue. He pointed out that the conditions today are different from the past crises period. The value of the euro and yen under permanent swap agreements with the dollar also have been falling sharply. The governor was warning against the financial market factoring in the political and popular opinion.

Rep. Sung Il-jong, policy chief of the People Power Party, said that Korea was able to ink a currency swap with America because relationship with Washington was good under conservative president Lee Myung-bak in 2008 and that the swap could not be extended under the Moon Jae-in administration due to poor bilateral relations. He is misleading. The U.S. signed currency swaps with central banks of nine countries — including the emerging economies of South Korea, Brazil, Mexico and Singapore — in 2008 after the global financial crisis and in 2020 after the breakout of the pandemic. The agreements also expired with all the countries at the same time. The U.S. maintains currency swaps with only four countries with internationally trading currencies.

The guidelines in selecting the four emerging economies for currency swaps were revealed shortly after a Federal Open Market Committee (FOMC) meeting in October 2008. For instance, given the relatively influential size of the economy and financial market, any upsets in one or two of the four countries could cause an adverse spillover in the U.S. and global economies. And since their fiscal integrity was managed well with sound current account and fiscal balances, a backup by the U.S. Federal Reserve during a temporary greenback drought could be helpful, according to the guidelines. The Fed chose sounder countries in the emerging category as their liquidity woes can be bad for the U.S. economy.

The argument for a permanent swap arrangement with the U.S. is far-fetched. The U.S. central bank has a permanent swap agreement only with liquidity-rich countries who host many multinational financial institutions with massive dollar assets and internationally trading currencies. Sadly, South Korea does not fit that category.

The finance ministry and the Bank of Korea would be feeling uncomfortable over the excessive reliance on currency swap. They would be regretting over-hyping of past agreements. They even leaked that some personal connections had helped in the arrangements, which bred a myth over a currency swap with the U.S.

I am not saying a currency swap is unnecessary. Authorities must maintain cooperative relationship with the Fed to flexibly employ the option in case of emergency and manage macro-economic data well. Eating well and exercising regularly keeps the good health. We must not rely on supplements or certain foods overly.
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