The Peninsula

Korea and Asian Markets Look to Enhance Trade in Currencies Other than the Dollar

By Troy Stangarone

As political gridlock in mid-October brought the United States to the brink of default for the second time in two years, world leaders and major holders of U.S. debt such as China called on the United States to take responsible actions to protect U.S. debt holders. However, at the same time that world leaders faced increasing uncertainty about the stability of the U.S. dollar as an international reserve currency, small steps were continuing in Asia to facilitate trade in currencies other than the U.S. dollar.

In recent weeks some of Asia’s biggest economies, including Korea, have concluded a series of currency swap agreements. These agreements are usually concluded to give countries access to short-term periods of foreign exchange reserves in times of a financial crisis.

Currency swaps became more common in Asia after the 1997 Asian Financial Crisis. During that crisis, countries in the region found themselves without adequate currency reserves to defend their currencies as capital flowed out of the region. As a result, countries began to pursue a policy of self-help whereby they built up foreign exchange reserves to defend their currencies. In time, a series of swap agreements took the form of the Chang Mai Initiative, which was multilateralized after the 2008 Global Financial Crisis.

However, unlike past agreements, the recent pacts are designed to help facilitate trade and make countries less dependent on the U.S. dollar rather than protect against a financial crisis. In the last few weeks, Korea has concluded agreements with Indonesia, the United Arab Emirates, and Malaysia worth $20 billion. Small sums in comparison to the $215 billion in trade Korea did with China last year, or the amount it does with other major trading partners such as the United States, Japan, and the European Union.

However, China is also gradually allowing for the direct trade of its currency with other partners. Recent deals with Singapore and the United Kingdom follow an earlier move to allow currency trading and bond purchases with Hong Kong.

To a degree, these moves are based on interests separate from uncertainty over the U.S. dollar. China is slowly seeking to boost the use international use of the renminbi and takes steps towards having and open capital account and fully convertible currency so it can compete for the status of reserve currency. For countries like Korea, direct purchases by central banks help to reduce the costs of trade by increasing access to foreign currency for commercial banks and allowing trade settlements to be done without dollars.

However, the role of uncertainty in the United States should not be underestimated in
the incentive it provides other states to seek alternatives to the U.S. dollar. As the world’s reserve currency, the United States has served as a safe haven for foreign investors. Foreign banks purchase U.S. Treasuries as secure assets within which to place their foreign currency reserves. This status holds benefits for the United States both in lower borrowing and transaction costs.  But the more often the United States faces political turmoil over financial issues, the more likely foreign investors are to seek alternative assets to protect their investments and alternative means for international transitions.

In reference to Korea’s latest deals, the Director General for the International Finance Bureau at Korea’s Ministry of Strategy and Finance said that “the latest deals are largely aimed at further strengthening economic cooperation,” and that “the reduced dependence on the U.S. dollar would eventually help [Korea] better cope with market volatility caused by the greenback.”

In the short run, these agreements will likely remain small and the U.S. dollar the primary medium of foreign transactions. According to the Bank for International Settlements, since 1989 the U.S. dollar has averaged 87 percent of all global foreign exchange market turnovers. Moving to an alternative would require the development of a large enough bond market with significant liquidity to meet the new demand.

But as some scholars such as Arvind Subramanian point out, the continued financial crises in the United States may only hasten the day when the Chinese renmenbi replaces the U.S. dollar as the world’s reserve currency. In the interim, we should not be surprised if more currency swap deals are struck in Asia to help facilitate trade without U.S. dollars.

Troy Stangarone is Senior Director for Congressional Affairs and Trade for the Korea Economic Institute. The views expressed here are his own.

Photo from bradipo’s photostream on flickr Creative Commons.