TCS Daily


Money Meddlers

By Christopher Lingle - May 1, 2006 12:00 AM

Vientiane, LAOS -- China is neither the only nor the worst currency manipulator. It turns out that Korea and Japan, two of America's closet allies in Asia, have been in the game for much longer. But as in the case of China, more damage is done to their own economies than to that of the US.

Consider the announcement of Korea's current government of plans to continue intervening in foreign currency markets. The intention is to curb further gains in the won that is up nearly 8 percent against the dollar since the beginning of the year on top of a 3 percent gain during 2005.

Various Korean officials have declared that the current upward movement in the won have been too rapid. Without empirical evidence or theoretical propositions to identify a "correct" rate of increase in or valuation of the won, perhaps they have consulted with the Delphi Oracle.

To support these steps, the Planning and Budget Ministry has abandoned plans to issue fewer currency stabilization bonds that are used to acquire funds to intervene on behalf of the won. A surge in monetary stabilization bonds occurred from growing foreign reserves that impose extra cost on the central bank and weaken monetary policy.

As it is, the BOK is expected to have to pay about 6 trillion won ($5.77 billion) in interest payments this year on monetary stabilization bonds floated to control the money supply. The interest payments on the bond totaled 5.58 trillion won last year.

These bonds and debts arising from an expansionary fiscal policy have grown more rapidly than GDP and have pushed up South Korea's public-sector debt beyond 200-trillion won. Future taxpayers will be forced to pay interest on these bonds.

But taxpayers will be also presented with a bill for foreign exchange losses from the so-called stabilization bonds. After all, the funds will be used to purchase a depreciating asset since the dollar is weakening against most other currencies.

Given the trend for the US dollar to weaken, intervention in foreign exchange markets will be fruitless. As long as there is an excess supply of the US currency, it will continue to weaken.

And so a question arises over why such futile but costly steps are undertaken. The answer lies in the fact that absence of economic logic never stops politicians or central bankers or finance ministry bureaucrats from feathering their own nests or those of their sycophants.

Governments usually declare that intervention on foreign currency markets is in the best interests of the country since it needed to maintain the momentum of economic growth from exports. But the most important reason for these actions is found in the political payoff of caving in to demands of Korean exporters that wish to avert a decline in their profits.

It turns out that a rise in the won does not directly affect the price of most Korean exports or the ability to sell them since many are priced in dollars. But the overseas earnings of exporters tend to be reduced when they convert dollars or other currencies into fewer local currency units.

Fiddling with the international value of the won is about helping this special interest group while imposing costs on most of the rest of the population. The costs imposed on most Koreans are likely to exceed the benefits to exporting producers and their workers that are a small minority of the total population.

After all, many companies and almost all consumers, benefit from a stronger won. For example, firms that import raw materials priced in dollars as well as companies with heavy dollar-denominated debts will be in a better position. A higher Korean currency reduces the cost of traveling overseas so that local airlines and travel agencies will likely perform better. Since steel companies and the food industry import much of their raw materials, they will fare better.

A stronger won will also reduce the costs of exporting companies with overseas production facilities. And it will reduce the burden of companies with dollar-denominated debt while offsetting the effect of higher oil prices.

Concerns over a loss in competitiveness ignore current realities. It turns out that the won closely shadows the yen and has developed a similar linkage to the yuan. Therefore, little ground will be lost in terms of the pricing of export goods with Korea's primary competitors.

Policy makers have ignored other ways to promote long-term growth. As it is, currency values are less important to long-run competitiveness than rising productivity.

It is more important to improve the investment and regulatory environment to encourage domestic and foreign investments that will boost productive capacity. Meanwhile, liberalizing Korea's foreign exchange market would allow dollars to flow more easily and readily out of the country.

In the end, decisions by individual market participants that are disconnected in their purposes and geographic space will determine currency values based upon economic fundamentals. Politicians and bureaucrats like nothing more than meddling with prices as a way of receiving electoral payoffs or power.

As hard as it may be for public officials to imagine, decisions made by large groups of faceless individuals display much more wisdom than they can ever muster. As such, it is better if prices of currencies are discovered in the complex interactions of human choices instead of through political design.

And herein an important lesson should be learned. Market-driven foreign exchange rates reflect economic fundamentals while currency market interventions actually destabilize these fundamentals.

Christopher Lingle is Senior Fellow at the Centre for Civil Society in New Delhi.

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