Asians help enforce monetary discipline in Europe
Diversifying reserves is part of strategy for more self-reliance
by David Marsh
Mon 23 Aug 2010
Be careful, Europe: Asia is watching you. That's the inexorable message from a series of meetings with Asian policy-makers over the past 10 days.
The word from Asia is music to the ears of Germany, the largest country in Europe's economic and monetary union and the one that is particularly in favour of cracking the whip over errant members of the single currency zone. Asia will maintain and even build up its investment in the Euro. But the quid pro quo, the Asians say, is that European decision-makers must be unrelenting in enforcing discipline in the indebted outlying nations led by Greece, Portugal and Spain. So the Asians have emerged as the Germans' strongest allies in supervising long-overdue stringency in the Euro's weakest states.
The largest reserve-holders among the Asian central banks, led by China and Japan but also including Singapore, Hong Kong, Taiwan and Malaysia, have a huge exposure to the European single currency, owning an estimated $1.5 trillion worth of Euros. This is because one way of lowering their dependence on the Dollar has been to step up Asia's reserve diversification in recent years.
This development was underlined by last week's news that China has stepped up its holdings of South Korean treasury bonds denominated in won. That follows hard on the heels of record purchases of Japanese bonds in the first half of the year. Chinese holdings of won Treasury bonds stood at $3.4 billion at the end of last year, according to official Korean figures. The Chinese State Administration of Foreign Exchange bought a record $20.3 billion of Japanese government bonds in the first half of 2010, almost seven times its purchases for the previous record year of 2005.
The acceleration of reserve diversification comes as Asian countries are laying down a series of initiatives to gain greater self-sufficiency in world economic and monetary affairs - a delicate balancing act. On the one hand, Asian countries are far from being a cohesive bloc and they are still prone to economic or political shocks. They certainly do not wish to place themselves outside Western-orientated mechanisms of international coordination, such as the International Monetary Fund, the Bank for International Settlements or the Organisation of Economic Cooperation and Development. Central bank credit swap lines with the Federal Reserve Bank of New York remain of paramount importance in times of crisis, whatever the talk of bilateral monetary support facilities built up under the so-called Chiang Mai Initiative (named after the Thai city where the policy agreement was reached in 2000).
On the other hand, signs of greater solidarity are unmistakable. Finance ministers from the 10 members of the Association of Southeast Asian Nations, plus China, Japan and South Korea, are slowly adding content and structure to their $120 billion multilateral currency-swap mechanism that became operational earlier this year. An office carrying the somewhat unlikely acronym AMRO is being set up in Singapore to monitor regional economies as part of the Chiang Mai initiative. The office, which will be established initially in the premises of the Monetary Authority of Singapore, is designated "ASEAN+3 Macroeconomic Research Office." (Those responsible for the appellation clearly were not unduly concerned about a potential association with the Dutch bank ABN Amro that was at the centre of enormous European banking losses in 2007.)
The Chiang Mai initiative could eventually grow into a reserves pooling scheme that could supplant the IMF as a conduit under which Asian countries make balance of payments loans. AMRO will take some time to come fully into being but could play an important part in this undertaking as a body that supplies not only technical assistance to central banks and governments but also enforces the conditionality of such loans. Such a development, which could mark a major challenge to the IMF, would be similar to the way in which European countries are now trying to make loans to countries like Greece subject to macro-economic conditions.
ASEAN countries, together with India, China and Korea, are also driving the build-up of local-currency bond markets in Asia, with the aim of lowering dependence on both the Dollar and the Euro for financing both large-scale Asian investment projects and also governmental and corporate needs outside the region.
For several years, China has been advancing with painstaking thoroughness toward internationalising the Renminbi as a means of lowering exposure to the fluctuations of the Dollar and the Euro. A further step in this direction came last week when China announced it will allow foreign central banks and overseas lenders to make significant investments in its domestic interbank bond market. Although only negligible amounts of Renminbi are held outside the country, the demand for Chinese bond investments is expected to grow as the currency maintains its gradual appreciation.
Over time, all this will lead to the Renminbi becoming a significant reserve asset and international transaction currency. But that won't become evident for several years. In the meantime, the Chinese and other Asian monetary authorities know that the best method for preserving the value of their Dollar and Euro reserve assets lies in encouraging genuine competition between the U.S. and European currencies. And this will involve the Asian countries straining every sinew, discreetly yet effectively, to implement monetary and fiscal rigor in Europe.
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