Asian Appetite for the Euro May Be a Barometer of Its Success

Perhaps no other part of the world will have as great a voice as Asia in establishing Europe’s new euro as an international reserve currency, and so far it’s looking good.

Many Asian investors and corporations have already jumped on the euro bandwagon in advance of its Jan. 1 introduction. For example, Japan’s biggest insurer, Nippon Life, promises to shift up to half its $34 billion in overseas assets into euros, much of that from dollars.

But the bigger test will be the support the euro receives from Asia’s central banks. Japan, China, Taiwan and Hong Kong alone boast nearly $1 trillion in foreign reserves.

Although the United States and Europe have a strong political interest in supporting their respective currencies as global reserves, the powerful Asian central banks have less at stake in the euro’s future role as a global currency. Thus their decision to move into--or shy away from--euros provides a more objective test of the new currency’s progress.

“Asian central banks are going to be quite a barometer,” said Michael Pitcher, Asia-Pacific vice chairman at Barclays Capital. “In terms of foreign reserves, the three richest states in the world are in Asia--Japan, China and Hong Kong.”

Asia’s appetite for euros will be driven by its desire to spread its risk and by how much confidence it has in Europe’s economic and political outlook, the continent’s ability to check inflation and social spending, and its growth prospects relative to North America and Asia.

A reserve currency is one that is easily convertible, widely used in global trade and commonly held by central banks. Since World War II, the U.S. dollar has been the world’s leading reserve currency.

That’s not to say that Asian nations don’t have their own interest in this financial power play. Reversing a long-standing policy, Japanese officials recently began promoting the yen in this role, apparently hoping to ride the euro’s coattails.

Analysts are skeptical, however, that Japan can make many inroads against the dollar or the euro in the near future--even among Japanese companies--given the yen’s volatility, Japan’s dismal economic outlook and the tendency of its bureaucrats to meddle.

Other Asian nations, meanwhile, having recently dropped their currencies’ direct peg to the dollar, may want to reduce their own dependence on the greenback.

The rise of a new global currency is relatively rare. The recent jockeying to weaken a global currency’s grip hasn’t been seen since the first half of this century, when the British pound gave way grudgingly to the U.S. dollar.

Why all the interest in having your nation’s printing presses crank out a world currency? For one thing, it becomes much easier to finance your government debt--a factor that helped the U.S. with its huge budget deficits in the 1980s--because underlying demand for your currency remains strong. It can also benefit your exporters, since their sales and most of their costs are in the global currency while foreign partners may have costs in one currency and sales in another, making them vulnerable to sudden currency shifts.

But the biggest incentive ultimately may be national pride--the status it gives your country on the global financial stage. “It’s what you might call economic machismo,” said Russell Jones, chief economist with Lehman Bros. Japan.

So far, most Asian central banks have been cautious about committing to shift out of the estimated 75% of foreign reserves they hold in dollars. China recently said it would reduce its dollar holdings in favor of euros, but countries such as Japan and Taiwan, with the largest U.S. dollar holdings, are reluctant to make a sudden move that could erode the value of their national nest egg.

“Japan holds 40% of the short-term U.S. government bonds, so it can’t afford to touch this,” said Hiroshi Sakurai, analyst with Japan’s Kankaku Research Institute. “China, on the other hand, has only a small percentage.”

Over time, however, given the sheer amount of foreign reserves held in East Asia--some $800 billion to $1 trillion, analysts estimate--even a relatively conservative 5% to 15% shift out of dollars into euros could sharply impact global currency markets by weakening the dollar. Over time, as the euro, dollar and even the yen jockey for position, it could also increase volatility, making it more difficult for companies to plan.

Compared with Asian central banks, however, many private investors and corporations are moving aggressively. In addition to Nippon Life, Japan’s No. 7 insurer, Yasuda Mutual Life, already raised its stake in European bonds by $1.2 billion during the six months ending in September.

“A large percentage of our funds were shifted to the European market . . . from the North American market,” a spokesman said.

Fukoku Mutual Life said it is also shifting its investments out of dollars into euros, at least for the short term while the economic fundamentals look good. Approximately 60% of its foreign holdings have been in dollars and 40% in European currencies. But three-quarters of its new money this year went into Europe, up from almost nothing the year before.

Other Japanese portfolio managers are expected to follow suit.

That said, analysts cite several factors that will tend to make Asian institutions move slowly. Most tend to be relatively conservative, and the euro has no track record, noted Robert Broadfoot, managing director with Hong Kong’s Political and Economic Risk Consultancy.

Asian financiers will pay special attention to Europe’s discipline and the ability of member countries to keep social spending under control.

“European politics are controlled by leftists, and they will most likely expand their finances,” said a finance official at Fukoku Mutual Life Insurance Co. “In the end, the euro may not work out.”

Some expect the euro to show initial strength before weakening against other currencies. Currency values ultimately mirror investment returns, said Marshall Mays, managing director of Hong Kong’s Emerging Alpha Asset Management, and over the next three to five years Asia will grow faster than Europe or the United States. This should boost Asian currencies at the expense of dollars or euros.

However, that doesn’t mean the yen will gain a place at the global table, several analysts said. Global confidence in Japan’s economy is very low, deregulation has been painfully slow and Japan rarely shows much international leadership.

“If Japan doesn’t become more assertive, the yen will never become an international currency,” said Kankaku’s Sakurai. “[And] deregulation is a must.”

Etsuko Kawase in The Times’ Tokyo bureau contributed to this report.