Friday, November 19, 2004

FX Angst at G20 meeting

The Economist covers the upcoming meeting of G20 finance ministers and central bankers. Who will be next (after Russia) to move to a reserve basket of currencies, shifting from dollars to euros?

...For a country such as South Korea, buying dollars is both costly and possibly inflationary. The country’s excess savings, parked in low-yielding American Treasuries, would earn a higher return invested at home. And the finance ministry’s weak won policy, by making imports more expensive, has hampered its fight against rising prices. In the summer, annual inflation reached its highest rate for three years, though it has since eased.

South Korea’s growing ambivalence about its won policy may be shared by the other post-crisis countries in the region. But their freedom for manoeuvre is limited by China’s dedication to its peg against the dollar. During the financial storms of 1997 and 1998, the peg provided an important anchor for the region. Even as currencies collapsed all around it, China refused to beggar its neighbours by devaluing the yuan. But China’s peg, a bulwark against the financial crisis, is now blocking the “reversal” of the crisis that Mr Jen foresees and the dollar needs. To its neighbours, China is such an important trade partner and competitor that they dare not let their currencies strengthen too far against the yuan. Even Japan is wary.

Much of the G20, then, is now waiting for just one of its members, China, to unpeg its currency. Some speculators can wait no longer. They are already swapping their dollars for yuan, betting it will soon jump in value. To deter such speculation, Chinese banks on Thursday raised the interest they pay on dollar deposits.

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