Global currency war deepening

Currency feud raises question over free-floating FX scheme

By Cho Jin-seo

The escalating “currency war” between the United States, China and Japan is encouraging Korea and other nations to thoroughly review their foreign exchange rate regimes.

The Korean government had not wanted the tricky Sino-American issue to spoil the G20 summit to be held in Seoul in November. But recent remarks from influential figures such as Dominique Strauss-Kahn, the managing director of the International Monetary Fund, and Sakong Il, the chairman of Seoul’s G20 committee, indicate that the issue will be unavoidable.

“The foreign exchange rate will be discussed in the upcoming summit as part of a global economic framework discussion,” Sakong acknowledged last Thursday during a promotional event of the G20 committee.

His remark reflects the general consensus reached at an international forum held on Tuesday and Wednesday in Seoul, where many participants such as former Canadian Prime Minister Paul Martin insisted the G20 treat the exchange rate issue more seriously.

On September 15, the Japanese government intervened in its currency market to stop the yen rising against the dollar. Since then, similar efforts were made elsewhere in the world. According to news reports, Korea, Singapore, Thailand, Taiwan, Indonesia and the Philippines all intervened in the market this week to stop their own currencies from rising. The phenomenon was dubbed as an “international currency war” by the Brazilian finance minister.

The so-called currency war is a race of countries trying to devalue their currencies against each other in order to keep their export goods more competitive in the global market and thus improve the balance of international payments.

Some analysts believe this seemingly ugly competition in fact has little harmful effect on the global economy, with no perpetual winner or loser.

In Thursday’s report, Kiwoom Securities said that the currency war is no more than another form of expansionary, economic stimulus policy, because governments have to inject money into the market in order to protect their currencies. “Eventually, the excess money is flowing into the stock and bond markets to help boost the economic growth,” it said.

New ideas

The increasing state intervention in many Asian currencies shows that governments in the region no longer believe that the free-market principle is always the best solution for the $4-trillion-a-day global foreign exchange market.

Korea knows the risk of a free floating system better than any other country. Its government officials have repeatedly claimed that the country needs more safeguards on the volatile won-dollar exchange rate, which is often the target of currency speculators in and out of Korea.

On Wednesday, Yoon Jeung-hyun, the Minister of Strategy and Finance, reiterated this view that the volatile foreign exchange rate is one of three main concerns for the Korean economy, along with the European debt woes and the global double-dip risk.

Now, the idea that the global foreign exchange system needs an overhaul is becoming a global consensus. On Saturday, the Financial Times reported that China and France have been having secret meetings this year on reforming the current global foreign exchange system, which is dominated by the U.S. dollar.

Nicolas Sarkozy, the French president, had called for a new Bretton Woods global financial architecture this summer, which includes a new worldwide reserve currency and bans on certain speculative practices. Sarkozy wants to make the foreign exchange issue the top agenda of G20 in 2011, when his country hosts the summit.

In a G20 committee conference in Seoul this week, Jacques Mistral, an economic advisor to the French government, said the IMF can and should have a bigger role in the future by using the Special Drawing Right as a global reserve currency, replacing the U.S. dollar from that position.

“Volatility is something we know very well,” he said, as he explains how much the euro-dollar rate has been fluctuating. “We know that there is something wrong with the judgment of the market.” Furthermore, he says that Korea’s foreign exchange debate can set some guidelines for the global discussion at next year’s G20 summit in Paris.

Seoul’s policymakers and regulators still play down the possibility of scrapping the free-floating system and going back to the government-controlled exchange rate system, out of worries that the country may be labeled as anti-capitalism ahead of the critical G20 meeting in November. But they are no longer shy to say in public that the controlled foreign exchange system would be more effective than the free-floating system in reducing volatility.

Chin Dong-soo, the chairman of the Financial Services Commission, the top regulating body, was unprecedentedly outspoken during a conference hosted by The Economist magazine last month, when he was attacked by foreign participants on Korea’s capital control policies.

“The Korean won is the riskiest currency in Asia. The easiest solution is to have a direct control on the exchange rate,” he said. “It would be the most desirable (solution), though we do not want to do that now.”

Political reasons

Top government officials often quote Shin Jang-sup, professor of economics at the National University of Singapore, when they need academic support on the foreign exchange reform issue. At the same conference, the journalist-turned-economist claimed that the free-floating system does not effectively reflect the fundamental value of currencies, because today’s $4-trillion-a-day currency market is moved largely by financial punters like hedge funds and investment banks.

“The FX sector is dominated by speculations But the Korean government didn’t do anything (during the crisis). It didn’t have the ability to control the inflows and outflows of money,” he said.

Shin thinks Korea should adopt the Singaporean system, under which the exchange rate can move within a boundary set by the government. And the idea seems to be gaining momentum. “To my understanding, after the recent global financial crisis, policymakers are gradually shifting toward the belief that we need some kind of control on this volatility,” he says.

On the other hand, Subir Lall, the International Monetary Fund’s Korea specialist, says that touching the exchange rate regime itself would be a mistake for the Korean government, because the rate is a mere index of capital flows.

“I think the worry about the volatility of the exchange rate is misplaced. What is more concerning is the capital flow affecting the financial system,” he said.

Lall defends the virtue of the free-floating system, that the sudden jump in the won-dollar rate during the 2008-2009 financial crisis actually released some pressure off the Korean economy _ a cheap won helped exports of Korean goods and discouraged foreign investors from selling assets in Korea. Changing the foreign exchange regime would also be a headache for the central bank as well, because it will reduce the market effects of monetary policies.

The government seems to believe that both the currency conservatives and reformists have a point. In a meeting with The Korea Times last month, a senior finance ministry official, who was deeply involved with Korea’s foreign exchange defense during the crisis, says that the ministry would vote for Shin’s idea if there are no political factors to be considered.

“Logically, what professor Shin is saying is right. But if we want to follow his advice and begin to set the exchange rate by ourselves, then we need to have a pool of smart, politically neutral decision-makers, like the ones in the Singaporean government,” he said.

“In fact, the controlled exchange regime is easier to manage for the government. The problem is that in Korea, the foreign exchange policy can be manipulated by politically interested parties because the power of export-oriented conglomerates is so strong in the economy.”

Conglomerates favor a high won-dollar rate because they can export at cheaper prices. The burden is put on the shoulder of importers and consumers who have to buy imported food and energy at higher prices. If the government takes control of the exchange rate, its currency policy may swing between the pro-conglomerate and pro-consumer opinions depending on the political climate of the time.

Another issue is involved in international politics. Many officials, such as Chin, the FSC chairman, think that it will make Korea look bad to its Western allies if it goes back to the controlled exchange regime, and that will undermine the government’s efforts to make Seoul an “Asian financial hub.” “It is a perennial challenge to deal with for Korea,” Chin says.

How the currency debate will develop is all the more important for Korea’s foreign exchange reformists, and vice versa, as the French economist Mistral sees. And it is evident that at November’s G20 Seoul Summit, China, Japan, the United States and the European Union will all try to steer the “currency war” discussion to its own national interest. It will be a messy process. But at least, Korea’s reformists won’t be feeling lonely anymore.