Currency Triangle
The Foreign Exchange took a fall on New Year’s Day, casting a shadow on the Korean economy. The won-dollar exchange rate fell below 1,050 won per dollar during the day. The won-yen rate fell as well to 997 won per 100 yen, repeating the gain of the last day of 2013 when it fell below 1,000 won before closing.
Foreign Exchange Authorities Declare Maginot Line of 1,050 Won per Dollar
On January 2, the exchange rate against the dollar fell by 5.1 won compared to the last trading day of 2013. In the morning it opened at 1,050.4 won, and closed at 1,050.3 won. Active trading typical of New Year’s Day, combined with the massive volume of outstanding balances that had been sitting idle, was released, and the floodgates opened. At one point during the day the won-dollar exchange rate fell to 1,048.3. The won-dollar exchange rate has not fallen below 1,050 since August 22, 2008 when it fell to 1,048 during trading. Finally, local authorities bought dollars to ease the free fall, and the rate of 1,050 won per dollar was restored.
Samsung Future Options Researcher Chun Seong-Ji said, “Foreign exchange authorities felt uneasy that 1,050 was broken on New Year’s Day. But because of the currency account surplus and volume that has been sitting idle, it is inevitable that the won will eventually fall below the 1,050 won mark.”
As the won’s rate against the dollar fell, the financial exchange rate, or arbitrage rate, against the yen also gave in. At 3 o’clock on January 2 the yen-dollar exchange rate was recorded at 105.31 yen per dollar, and the won-yen exchange traded at 997.44 won per 100 yen. It broke the 1,000 won barrier on December 30 of last year, and again fell, finally settling into a three-digit figure.
35.3 Percent Gain Against Yen in Just 15 Months
The exchange rate had once fallen drastically when the US fiscal cliff negotiations ended in January 2 of last year. Then the government acted swiftly to protect the won by imposing macro level prudential policy. But the foreign exchange authorities’ perspective this year is more complex. Not only does the US begin the tapering of quantitative easing this month, but Japan is instituting a sales tax hike to take effect in April. Also, unlike last year, the global markets are allowing Japan’s deliberate depreciation of the yen. To make matters worse, Korea has just recorded its highest ever account surplus.
From a historical perspective, the trend of the won’s exchange rate is worrisome. According to Hyundai Research Institute, observing the yen’s weakness shows a shocking pattern. During the first period between May 1988 to 1990, following the US’ S&L bankruptcy crisis, the won gained 27 percent in value with the dollar. Then between June 1995 to July 1996 (the so-called Plaza Accord age) and from December 2004 to June 1997, the won again saw 21.3 percent and 33.7 percent gains. During the fourth period since September 2012, dubbed the Abenomics period, the won has risen a whopping 35.3 percent. This is a chilling revelation for Korea’s export business.
If this year’s annual yen-dollar exchange rate is 105 yen to 1 dollar, gross exports will be down by 2.2 percent.
Analyst Manager Lim Hee-jeong of Hyundai Research Institute said, “Domestic consumer confidence is weak. The financial and real economy are both expected to take a major hit.” Then he said, “If this trend of the won’s gain continues like this, it will be necessary to consider further lowering the interest rate and increasing liquidity.”
Carry Trade Will Have Little Merit
The rapidly falling yen has fueled interest for carry trades, as well. Cheap yen can be bought and re-invested in another currency. However, it is unlikely that carry trade will be attractive, like last year, according to market experts. Currencies such as the yen, euro and Australian dollar, which are widely used in carry trades, will only weaken, as they will be using monetary policy that is against the current tide of the US’s tapering of quantitative easing.
Forex Team Manager Chung Kyung-pal said, “Korea’s fundamentals are healthier than other Asian countries. Foreign currency can overflow, driving up the won, but with the tapering of US dollars just beginning, the currency gain will be limited, and there will be little to profit from the exchange of foreign currency.” Then he added, “With the exception of US dollars, which has a direct impact on the stocks and bonds market, other currencies are likely to end up in cross currency trade, within the confines of the exchange rate market.”