LONDON (MarketWatch)—Asian central banks are in a nervous mood about both the euro and the dollar.
When the European single currency was founded 14 years ago, many Asian central banks—not just the Chinese—saw the new arrival as economic and monetary salvation.
No longer would international reserve holders and other institutional-asset managers have to rely solely on the dollar with all its shortcomings. The international-asset-management community would have access to an alternative currency that would compete with the greenback in attractiveness, reliability and value.
Outlook for growth even gloomier
Global growth has been slowing but financial markets have remained optimistic that politicians will come riding to the rescue. Now, though, hopes of political leadership are fading fast.
But it was an illusion to believe that the euro would emerge as a stabilizing dollar counterweight with positive consequences for the global economic balance. So Asia is now attempting to develop long-term economic and monetary policy alternatives to reduce dependence on the world’s two major reserve currencies.
The movement toward Asian interdependence isn't new. For years, Asia has been increasing common ground in areas such as financial-market integration, banking supervision and mutual-credit mechanisms and swap lines. These trends have been accelerated by the ever more contradictory state of economic and monetary union.
Heterogeneous Asia regards the U.S. as an intact, though federally organized nation—irritating sometimes, but on the whole predictable. Since the 1950s, Asia has seen Europe as an integration model to be followed: a network of independent states, frequently at war, doing its best to overcome history, dismantle barriers and solve its problems by joint action. Now they are not so sure. Asia has been shocked by the Greek state bankruptcy in February 2012. Involving a debt of more than $350 billion, this was more than five times greater than the most important sovereign default hitherto (Argentina in December 2003 with $81 billion).
Reuters
And the aftermath has been increasingly messy, too. As a senior Asian central bank official puts it: “We always thought the Europeans had better systems and better people. Now we doubt whether this is so.”
Prasarn Trairatvorakul, governor of the Bank of Thailand, summed up the point a few weeks ago in London. The Southeast Asian countries recovered relatively quickly after the Asian financial crisis of 1997-98, regaining competitiveness through rapid depreciation and general economic policy flexibility. “However this flexibility isn't practical for Europe given its single currency setting and attendant political complexities.”
All these considerations become concrete when we look at the losses on the currency reserves of many Asian central banks, which after their post-1998 recovery have become by far the world’s largest reserve holders.
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Asian central banks usually invest in low-interest government securities denominated in the dollar and the euro, which themselves tend to depreciate against local Asian currencies. The central banks’ liabilities are primarily denominated in the state’s own currency, where interest rates are much higher. A glaring currency and interest-rate mismatch that is exposing some leading Asian central banks to the politically sensitive requirement of seeking substantial government injections to help plug losses in their balance sheets.
There are only really two ways out of this dilemma, long-term.
Either a sharp reduction in these countries’ foreign-exchange reserves, which can come only in the wake of better world economic balance and therefore likely will take years to achieve.
Or the development of alternative assets, primarily through purchases of Asian foreign currencies. Central banks in countries such as China, Indonesia, Malaysia, South Korea and Thailand are already practicing mutual-reserve holdings of their respective currencies. Although the markets are small and relatively illiquid, this trend is bound to continue, albeit gradually.
Mindful of Europe’s dire lessons, Asia is determined not to introduce their own single currency. But the contours of a more integrated Asian economic and currency area are becoming ever more apparent.
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