You Can't Bet Bottom Dollar

By Tom Plate
The Korea Times, Seoul
Sunday, March 13, 2005

http://times.hankooki.com/lpage/opinion/200503/kt2005031318135054240.htm

LOS ANGELES -- Fasten your seat belts and get ready for a major test of the core stability of the global financial system.

How do we know that a jolt is coming? It's simple. Just consider:

-- How world markets went into a serious dipsy-doodle dollar tailspin the other day after Japanese Prime Minister Junichiro Koizumi raised the specter of his treasury "diversifying" its foreign-currency holdings. Implicitly referring to Japan's huge
savings pile of $840 billion, Koizumi bluntly told a Diet
parliamentary committee: "I think it's necessary to have diversity." The prime minister's candor then triggered a selloff of U.S. treasury investments by foreigners (who feared a plunge in the value of the dollar) that jacked up some U.S. bond prices to a seven-month
high. Today's markets are nervous about excessive foreign capital flows into the United States -- and they should be. Imagine an alcoholic whose friends "help him out" by delivering vodka instead of milk bottles to the door every day for breakfast. This is what in
effect Japan (solid ally) and China (sometime economic partner) are doing by providing foreign funds to an American culture that is overspending and under-saving.

-- How Japan and China will continue to act this way, right up until the dollar breaking point, because the practice is in their economic interest. The large-scale dollar-buying keeps the exchange-rate value of their countries' own currencies from rising too high, which
would raise the price tags of their exports in the all-important U.S. market.

-- How so many officials moved so quickly to poo-poo the selling frenzy as a minor overnight down-tick. All rally-round-the-currency syndromes rightly make us extremely nervous. For starters, Japanese economic officials quickly sought to downplay the prime minister's
comment. Said Hiroshi Watanabe, vice minister of finance for international affairs, "We don't plan to take action now at all" to diversify out of dollars. Although Japan "is always considering if it's appropriate in the long run" to hold its reserves in certain securities, he added, "nobody is considering" a shift out of dollars
now. Notice, though, the qualification "now" -- twice in those two sentences alone. And note the feel-good debt-serving comment of U.S. Treasury Secretary John W. Snow, who said, "The U.S. remains the best, safest, most secure place to invest in the world. Our markets here are the deepest, the most liquid, and most efficient anywhere
in the world. We produce the best risk-adjusted returns, so no, I'm not worried."

Well, I am.

-- How a nightmare scenario -- of a possible stampede from the dollar -- would play out emotionally in a place like Asia. Remember, China and Japan together account for about 77 percent of these foreign dollar holdings. Both countries benefit enormously from strong American consumer demand and a strong dollar. But they also
remember how crudely and rudely the United States conducted itself during the Asian financial crisis (1997-98). Washington let troubled Asian countries stew in their own negative economic juices, prevented Japan from taking a strong role, repeatedly offered China
bad currency advice, and didn't pitch in to help until the currency virus was almost on its own doorstep.

To conclude: Asians remember things; Americans do not. "One of America's biggest strengths is that it is a nation with limited memories," writes the astute Kishore Mahbubani in his new book "Beyond the Age of Innocence," a truly timely and essential volume of Asian political wisdom. "Asians, by contrast, have long
memories. They can recall important historical events. The Asian financial crisis will be remembered for a long time. The lessons will be complex. But one clear strand will emerge in the historical memory: how a generous country walked away from them in their hour of need."

The Bush administration is scarcely responsible for the sins of the predecessor administration. But, like it or not, it inherits those Asian memories, and even though it is very much in the interests of Asia to not see the U.S. economy fall on its face, Asians are human
like the rest of us. Just as Osama bin Laden punched America in the face on Sept. 11, 2001, and some people in the world cheered, don't be surprised if Asia were to be forced into executing a serious run on the U.S. dollar and few tears are shed in Asia.

Perhaps the only question is which Asian nation will be the first to "diversify" from the dollar in large quantities. The truth is that no one wants to be the first out the door in the selloff. But
it is also true that no one wants to be the last out the door when and if a dollar panic sets in. Keep those seat belts in sight.