Asia’s Stockpiles of Dollars Pose U.S. Economic Risks

A massive buildup of U.S. dollars held by Japan, China and other Asian countries is fueling increasing unease among analysts and policymakers, who fear it poses risks to the fragile American economic recovery and global financial stability.

Collectively, Asian countries hold foreign exchange reserves -- mostly in dollars -- valued at more than $2 trillion, nearly triple that of just seven years ago, according to the Asian Development Bank. Those dollar holdings continue to grow rapidly, with the Japanese and Chinese governments particularly heavy buyers.

Asian governments buy dollars because it helps boost their export-led economies. Snapping them up keeps the greenback’s value high and the value of regional currencies low, giving Asian countries a vital competitive edge in foreign markets.

Though this strategy makes a Chinese-made toy or a Japanese TV set cheaper for Americans and other global consumers, it has serious side effects. The dollars that Asian countries rake in as payments for those exports further boost their already bloated reserves while the record U.S. trade deficit grows even larger.

But that’s not all. Asia’s dollar purchases also effectively finance the huge and growing U.S. budget deficit as central bankers in the region invest most of their dollars in U.S. Treasury bonds and other securities. They have done this with such gusto that Uncle Sam doesn’t even have to offer higher rates to move the average $1.5 billion of Treasury securities it must sell each day to sustain the current year’s deficit.

Without that demand, the United States would have to offer higher interest rates to lure buyers -- a move that would drive up rates on mortgages, business loans and more.

That, experts say, is the danger.

Any significant drop-off in Asia’s seemingly insatiable appetite for the greenback would trigger a rise in interest rates that could slow U.S. growth and depress a job market only now showing its first signs of recovery. “Right now, it is Asians who are helping keep U.S. interest rates low,” summed up Kenneth Courtis, Asia vice chairman for American investment firm Goldman, Sachs & Co.

The connection between Asia’s central bank policies and America’s economic well-being stands as a startling -- and, for some, unsettling -- example of how the fates of people living oceans apart have become so closely intertwined by the forces of globalization.

In an age where an American thinks little of getting an update on a credit card balance from someone sitting in Bombay, it is now the Finance Ministry bureaucrat in Tokyo and the banker in Karachi who influence mortgage rates for homeowners in Phoenix or Des Moines.

Asia’s “dollar habit” also poses other risks to Americans, experts say. By allowing the U.S. to pile up record deficits without having to pay the usual price of higher interest rates, Asia has effectively encouraged Congress and the Bush administration to amass even more debt.

If U.S. budget deficits continue to grow unchecked, they could, among other things, eventually endanger the government’s ability to finance Medicare and Social Security programs once baby boomers begin retiring.

Though few economists believe it will go that far, they agree that bigger deficits could lead to tougher and more painful adjustments for Americans.

“The longer this goes on and the larger the debt becomes, the more likely it is that it will lead to a recession in the U.S.,” declared Geoffrey Barker, chief international economist for Hong Kong & Shanghai Bank Ltd. in Hong Kong.

Lately, hints have emerged that Asian governments may be reviewing their positions. Foreign-currency traders report that the frenetic pace of Japan’s dollar buying during the initial months of this year has eased noticeably during the last couple of weeks. And there are signs that some countries have begun to divert investments into their domestic economies rather than buying so many Treasury securities. But these movements remain small.

Historically, most foreign countries have held some dollar reserves to pay for imports and to serve as a cushion in time of crisis -- much as a family would maintain a savings account. Asia’s dollar reserves were already at an all-time high two years ago when the region’s central banks began buying the currency to prop it up as it began to fall under the weight of the growing American deficits and uncertainty surrounding the war in Iraq.

Many Asian countries see dollar buying as a matter of economic survival -- the price they must pay to keep the greenback high, their own national currencies low and their export goods priced competitively in a dollar-dominated world.

“From India to Japan, Asia adheres to a strategy of export-led growth and that requires an undervalued currency,” noted Tim Condon, chief economist for ING Financial Markets in Hong Kong.

The strategy has worked. According to Federal Reserve statistics, the greenback lost 8.4% of its trade-weighted value against world currencies over the year ended in February, an amount that international economists suggest is about half of what it would have fallen without Asia’s interventions.

Because its goods have remained cheap for Americans, Asia as a whole enjoys a large and growing trade surplus with the U.S.

Asian countries also have another incentive to accumulate dollars.

By amassing greenbacks, Asian governments could quickly convert that money into their own currencies, helping stabilize them in the event of a financial crisis. In this way, dollar reserves become a tool for avoiding a repeat of the speculative attack in 1997 that sent the Thai baht into a frightening tailspin and quickly spread throughout the region. Eventually, the International Monetary Fund was forced to step in and impose draconian measures as part of a massive bailout package.

The harsh medicine administered by the IMF turned out to be both economically ill-suited and politically disastrous, delaying recoveries and, in the case of Indonesia, leading to the fall of the nation’s leader, Suharto.

“Politicians with a survival instinct vowed never again to be forced into a position where they had to deal with the IMF,” noted Ifzal Ali, respected chief economist of the Asian Development Bank in Manila. “For them, large dollar reserves were a firewall to guard against this. It became an obsession.”

Last month, Taiwan put the strategy into action. U.S. dollar holdings allowed Taipei to ride out the sharp sell-off of its local currency that accompanied a post-presidential election crisis. Central bank Chairman Perng Fai-nan told a legislative committee four days into the political turmoil that he had an “unlimited” ability to spend dollars to buy back the local currency from all those wanting to sell.

Even in Asia’s poorest countries, dollar reserves have jumped. Pakistan, for example, which counted $535 million in foreign-exchange reserves at the end of 1996, boosted that to $10.6 billion at the end of last year. The pattern is similar in other countries.

In the first quarter of this year, Japan alone bought about $145 billion in additional dollars and recently won parliamentary approval to buy $360 billion before year-end. China last year added about $160 billion to its reserves. While nations keep their reserves in various currencies, roughly two-thirds of these holdings are believed to be in dollars.

At one level, this represents a very real loss of U.S. government control over the national currency, one with genuine national security implications. Any carefully organized dollar sell-off by these countries or a traumatic event that stampeded them into panic selling could send the dollar -- and the global financial system -- into chaos.

Such a scenario, however, is widely dismissed as highly improbable because central bankers and government policymakers in the region know that, as the world’s largest international dollar holders, they would lose more than anyone from an attack on the American currency.

But there are growing reasons that Asian nations might want to pare their dollar habit, experts say.

As Asian economies continue to grow briskly and export growth begins to ignite domestic economic strength, many policymakers are coming to view huge dollar holdings as an inefficient way to use national wealth.

“The reserves now held [in Asian central banks] far exceed the optimal level,” noted economist Ali. “It’s only now dawning on policymakers that there’s a very high cost to this.”

Ali noted that Treasury bills offer some of the world’s lowest rates of return -- far below what fast-developing Asian economies could earn putting those dollars to work in their own economies. There is already evidence this may be starting to happen, albeit in relatively small amounts.

South Korea and Taiwan are reportedly preparing to invest some of their reserves directly into their domestic economies, and a major debate is underway in India about making better use of reserves that recently topped $100 billion for the first time.

“This is money that isn’t working with any efficiency at all,” said Deepak Lal, an international development specialist and economist at UCLA. “It’s a real loss.”

Even a slowing of dollar buying or a measured unwinding of reserves in Asia would be felt in the United States, which must sell such large volumes of dollars to finance a federal deficit projected at more than $500 billion this year.

While Ali has maintained that Asian countries should diversify their reserves more evenly among a basket of currencies, central bankers claim there are few choices. They say the yen is not an option because it effectively shadows the dollar, while the stability of Europe’s euro remains unproven after barely two years in circulation.

“At the moment, there’s no way out of the dollar,” explained Rafael Buenaventura, governor of the Central Bank of the Philippines.

Because of this, Asia’s dollar buying continues despite mounting disquiet about the buildup.

If Japan moves ahead to buy the additional $360 billion recently authorized by parliament, it would push that country’s dollar reserves above $1 trillion.

That prospect makes some Japanese analysts nervous.

“They’ve accumulated such a huge amount [of dollars] already that it will be very difficult to sell them quickly,” Sayuri Kawamura, chief researcher at the Japan Research Institute in Tokyo, said of the government. “It takes time [and] I’m afraid it will be too late once they notice, or if they miss the timing, to start selling.”

At some point, economists are convinced, the U.S. will be forced to take corrective action to rein in its deficits. But these experts also believe the political costs are probably too high for the administration to act on its own prior to the November election.

Still, they stress that developing a plan that can steer the world economy through an orderly adjustment must be among the first tasks for whoever resides in the White House next year. A delay well into the year could easily undermine confidence in the greenback, spook central banks in the region and possibly start a wave of uncontrolled dollar selling, the experts say.

“Eventually, the United States will have to address the deficits,” Buenaventura said. “Once this happens, things can get back to normal. Meanwhile, Asia can’t afford to let the dollar drop further.”

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Researcher Hisako Ueno in The Times’ Tokyo bureau contributed to this report.

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Building up reserves

Asian countries’ accumulations of foreign currencies have swollen in recent years. Most of those reserves are in U.S. dollars.

Foreign exchange reserves in 2003 (In billions of U.S. dollars)

Japan $652.8 China 403.3 Taiwan 206.6 South Korea 154.5 Hong Kong 118.4 India 97.6 Singapore 95.0

Sources: IFS Online, People’s Bank of China, Central Bank of China