Reversal of fortune

Korea’s reserves fell by about $10 billion in July -- a bigger fall than in November 1998,* at the height of Korea’s crisis. Korea, of course, has WAY more reserves now. It can afford to intervene heavily -- as it clearly did earlier this month. The release of its reserves data just confirms something that the FT, among others, have already reported. Indeed, the reported fall in Korea’s reserves was a bit smaller than the $15 billion some expected. Some estimates even put Korea’s July intervention at close to $20 billion.

The fall in Korea’s reserves though highlights an important shift: many Asia’s currencies have decoupled from the Chinese yuan. There is still pressure on the yuan to appreciate,and China is still buying a lot of dollars to keep the CNY from appreciating. But a lot of other Asian countries are now selling dollars (and euros) to keep their currencies from falling.

This is a shift. In 2005, 2006 and 2007, most emerging Asian economies (Japan is different story) faced pressure to appreciate. Most were adding to their reserves. And many had currencies that appreciated faster than the Chinese yuan. That was even true in the first couple of months of this year, when countries like India and Thailand were all buying dollars to keep their currencies from going up.

Now, these countries -- and countries like Korea that didn’t face the same pressure to appreciate earlier in the year -- are all intervening to keep their currencies from falling. And for the first time in a long time, their currencies aren’t going up faster than the Chinese yuan.

Indeed, many emerging Asian currencies have depreciated against the dollar this year even as the yuan has appreciated. In 2006 and 2007, the slow pace of CNY appreciation was a constraint on faster appreciation elsewhere in Asia. Now, the depreciation of other Asian currencies seems to have become, if anything, a constraint on further appreciation of the yuan.

So why have the fortunes of China’s currency and many other Asian currencies diverged?

First, the appreciation of other Asian currencies over the past few years had real consequences. China has become India’s largest trading partner, largely because Indian imports of Chinese goods have soared.

Second, and no doubt more important, the sharp increase in the price of oil has created far more strain on Asia’s "deficit" economies and on its "surplus" economies. Countries whose current accounts were balanced -- as well as countries that ran small deficits -- with oil at $70 a barrel are now running significant current account deficits. China will still run a large current account surplus even with oil at $120. The runup in the price of oil and other commodities has kept China’s trade surplus from expanding, but it has yet to bring it down in a significant way. Right now, China’s nominal current account surplus looks likely to be roughly constant in 2008.

That could change if Europe slows dramatically, leading to a big slowdown Chinese export growth in the second half of the year and if -- even in those conditions -- commodity prices remain high.

But as of now, other Asian economies have been squeezed far more than China by the rise in commodity prices.

* Korea’s reserves would have fallen significantly in December 1997 as well if not for loans from the IMF and World Bank