Analysis: Falling dollar rattles Asia

SINGAPORE, Nov. 29 (UPI) -- The U.S. dollar has been falling inexorably against Asian currencies in recent months, with the trend accelerating in recent weeks. For Asia, the danger is that a weakening greenback could push the region into deflation, low growth and strong currencies for years to come.

"This is a crossroads for Asia. It is in the overwhelming interest of the region to fight back," said Andy Xie, Asia chief economist at Morgan Stanley. "I believe Asian central banks should sell their holdings of U.S. Treasuries now. A weakening currency should lead to higher bond yields. However, because Asian central banks hold huge amounts of U.S. Treasuries, U.S. yields have not reflected U.S. dollar policy. This lack of pain is encouraging the U.S. to pursue its devaluation policy. If Asian central banks dumped their treasury holdings for short-term paper, the U.S. government would have to balance between a weaker dollar and higher bond yields," Xie said.

Last week, market got jittery after it was pointed that China, the second- largest overseas holder of the securities, might have reduced its holdings in U.S. debt in its foreign-exchange reserves to $180 billion, something that was later denied. The speculation on China's appetite for Treasuries followed news the Russian central bank was planning to step trying to peg the ruble solely against the dollar, shifting instead to a target based on a basket of currencies. First Deputy Chairman Alexei Ulyukayev also said Russia was likely to increase the amount of euros in its reserves, thus diversifying away from the dollar.

"The news that Russia is diversifying its reserve holdings out of U.S. dollars cannot be lost on Asian central banks, some of which like Korea are experiencing losses on their intervention operations this year," noted Tim Condon, analyst at ING Financial Markets.

Korean has been particularly hurt by the weaker dollar as the won has appreciated 10 percent in the past three months alone against the greenback, outperforming other Asian currencies. The won is now at a 7-year high against the U.S. dollar, while the Singapore dollar is at a 6-year high and the Taiwanese dollar at a 4-year high. Since the start of the year, the dollar has weakened almost 14 percent against the won, nearly 6 percent against the Taiwan dollar and over 4 percent against the yen.

Indonesia has already indicated that it may reduce holdings of dollars and U.S. Treasuries in its foreign exchange reserves if the dollar continues to fall. Others are expected to follow suit.

U.S. Federal Reserves data showed foreign official and international accounts - mostly central banks - bought $3.038 billion of U.S. Treasuries and U.S. agency securities in the week ending Nov 24, down from $7.763 billion the week before.

Xie argues that the strategy of selling US Treasuries should not be financially costly as most Asian economies have short-term interest rates lower than or at 2 percent. "Japan, in particular, could keep the dollars that it buys locked up. With a zero short-term interest rate, Japan could do this indefinitely. It would effectively neutralize the hedge fund flows into Asia and force US bond yields to reflect fundamentals," Xie said.

There are several steps Asian economies can take to safeguard their interests. For once, they could shorten the duration of their dollar reserves. "Asian central banks have been purchasing US Treasuries when they buy dollars from hot money or trade surpluses. This action has artificially kept the U.S. bond yield low, which has boosted the U.S. housing market and consumption through mortgage refinancing. If Asian central banks keep their dollar reverses in money market, the dollars would go back to the Fed, as it targets short-term interest rate," Xie added.

Second, Asian central banks should start thinking about the monetization of government debts, as the willingness to dilute the currency value would dissuade hot money from pushing up their currencies.

"When Asian central banks show their willingness to dilute the value of their currencies, it would be a powerful signal to their domestic businesses that they should not panic despite the recent currency appreciations. When the odds of such panic are low, the hot money is likely to leave, Xie said.

Eventually, Asian economies needs to seat down with the U.S. to discuss how to correct the global imbalance. For this, Japan will play a key role and should be motivated as a yen appreciation could well push it back into deflation.

Yet many economists are doubtful the Japanese are willing to so because so far there has been no indication of massive currency intervention to stem the rise of the yen.