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South Korea, Asian Export Economies Grapple with Dollar Dilemma

South Korea has dropped plans for now to diversify its massive foreign exchange reserves away from the weakening dollar, despite indications in February there were plans to do so. The dollar's drop creates a policy dilemma for export-driven Asian economies like South Korea.

Park Seung, the governor of the Bank of Korea, says his government needs to keep piling up dollars because shifting its foreign currency reserves toward euros or yen could weaken the greenback further.

That would be bad for South Korea's exports. If the South Korean won strengthens against the dollar, South Korean goods get more expensive on world markets. The result, says Citibank economist Oh Suk-tay in Seoul - plunging profits for exporters. "If the dollar slides, then clearly proceeds in Korean won terms decline - maybe more than 10 percent in [the past] one year I think," he says.

In South Korea, it has been particularly tough over the past year, as the won has risen 12 percent against the dollar.

Many Asian governments have traditionally piled up large U.S. dollar reserves, largely as a protective hedge against economic instability. Building dollar reserves has not been hard, since most Asian economies are dominated by exports and domestic consumption is low compared with Europe and the United States.

South Korea has the world's fourth largest foreign exchange holdings, at around $200 billion. China, Japan, and South Korea combined hold more than $1.5 trillion in foreign currency.

Mr. Oh says any signs of a change in dollar holdings by these governments resonates instantly in financial markets. "If the Asian central banks try to sell the dollar and buy the euro or the yen, that news could spread through all of the world," he says.

Bank of Korea Governor Park found in February just how quickly a single comment can cause the dollar to plunge, when he said the central bank might adjust its holdings to be less dollar-heavy. The dollar almost immediately dropped below 1,000 won for the first time in seven years.

Mr. Park's remarks, and later reversal, highlight a dilemma facing export-dependent countries with large dollar reserves.

Holding large amounts of dollars is a problem when the buck is weak - as it has been over the past few years - because the holdings lose value. Yet shifting to reserves to other currencies weakens the dollar further.

The dollar's weakness stems from a number of factors - chiefly the burgeoning U.S. trade deficit, which in February hit a record monthly high of more than $61 billion, and the soaring U.S. government budget deficit. In addition, many Asian economies have been strong in the past few years, which bolsters their currencies.

Economists say the textbook answer to the problem is for the United States to curb its deficit spending, and for Asian economies to boost their domestic consumption. However, policy experts have advocated that formula for decades without success.

Jeong Yeong-sik, at the Samsung Economic Research Institute in Seoul, says the dollar will probably continue to weaken as long as U.S. deficit spending and Asian export growth keep feeding off each other.

He says a possible long-term solution for the region is Asian economic integration, similar to the European Union.

Mr. Jeong says in terms of economic size, he thinks Asian countries have become strong enough to counter the United States, but coordination of their foreign exchange policy is not yet sufficient. Expanding regional mechanisms like the Association of Southeast Asian Nations, he says, is a good early step.

In the meantime, economists such as Mr. Jeong say that Asian central banks may simply have to brace for the greenback to continue its slide.