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What to Do About Asia's Savings?


While saving money can be a virtue, many experts warn that the vast foreign exchange reserves Asian governments have piled up could be risky. During the past few years, China and other countries in East Asia have amassed more than $3 trillion worth of foreign exchange.

East Asia represents around 40 percent of the world's gross domestic product, but it controls an estimated two-thirds of the world's foreign exchange reserves. Much of this built up over the past three years and experts say if the pace continues, East Asia will have 75 percent of the world's reserves within five years.

After massive currency speculation and a financial collapse depleted Asia's reserves in 1997, governments piled up savings to protect against another crisis. In 2004, South Korea's reserves were double the level in 2001. China says its reserves rose more than 34 percent in 2005 to $819 billion dollars -- nearly four times the level in 2001.

Much of this money comes from export earnings and foreign investments flowing into the region. Asia's trading partners, however, argue that some of this growth is due to undervalued currencies, which make Asian exports artificially cheap.

Global Market Stability at Stake

These reserves worry many economists. Professor Park Yung Chul of Seoul National University says governments have more than they need: “The accumulation of reserves by Asian countries, especially East Asian countries, is not an optimal and very desirable development."

Park says the situation could endanger global market stability. That is because most of the reserves are in U.S. assets, primarily Treasury bonds. That effectively makes Asia a major lender to the U.S. government, helping finance America's burgeoning trade and budget deficits.

But economists warn if investors lose confidence in Washington's ability to deal with its deficits, they could sell their dollars -- which would weaken the currency. A particularly sudden loss of confidence in the dollar -- sparked perhaps by new terrorist attacks or a surge in oil prices -- could send financial markets into a freefall.

Frank Harrigan is an economist with the Asian Development Bank, a non-profit lender in Manila. "If there were an abrupt halt in the demand for U.S. dollar assets, the dollar could then depreciate quickly and force the Federal Reserve to hike interest rates. This could push the U.S. economy toward recession and the knock-on effects on the global economy including Asia would then be serious," says Frank Harrigan.

A U.S. recession would mean lower demand for Asian goods, which could drag down the region's economies. Moreover, a weak dollar would lower the value of the very reserves Asian central banks have piled up to protect themselves from market turmoil.

Ideally, economists say, Asian central banks should spread their reserves into different currencies. But they warn, at this point, shifting currencies could be risky because it might cause the very loss of confidence in the dollar many economists fear.

Jan Lambregts, an economist in Singapore for the Dutch-owned Rabobank, says that would particularly cause problems for countries that limit how much their currencies move against the dollar. Countries such as China and Malaysia could be forced to buy dollars to keep their own currencies stable if the greenback is falling.

"China would be facing the dilemma indeed that okay, the dollar's weakening, if we want to manage our currency we have to intervene again and accumulate even more [dollars]," says Jan Lambregest.

To reduce risks, experts say Asia needs to wean itself from relying on exports for economic growth.

Surplus Driven by Few Domestic Investments

Harrigan of the A.D.B. says Asia is not spending enough at home and should be using reserves to build infrastructure -- roads, ports, power systems, water supplies -- and to stimulate domestic consumption. That, economists say, would promote long-term growth."In Asia, low levels of domestic investment explain much of the current surplus we now see across the region. The types of measures that would be more suitable are structural rather than macro-economic, they would be measures aimed at improving the climate of business and making the operation of the financial systems more efficient and safer," says Harrigan.

Many U.S. and European officials also say ending rigid exchange rate systems would help solve the problem, because stronger local currencies would cut trade surpluses.

Cutting those trade surpluses also could improve relations with other governments. Increasingly politicians and business leaders in Europe and the United States are threatening protectionist action. They complain their countries are losing jobs because of predatory pricing by Asian manufacturers. Stronger currencies would make Asian exports less competitive overseas.

Asian governments, however, are unlikely to abandon their export-oriented economic blueprint any time soon -- simply because it is has been key to their growth. And calls for liberalizing managed exchange rate systems have yielded limited results.

Rigid Exchange Rates

Under international pressure, China last year ended its currency's peg to the dollar and has allowed the yuan to trade within a narrow range against a basket of currencies. But the move has not satisfied the U.S., which wants full liberalization. Some U.S. congressmen have threatened to impose sanctions on Chinese exports if the yuan does not appreciate.

Some economists say foreign exchange adjustments are only one piece of a complex puzzle and may not work as well as hoped in correcting trade imbalances.

A recent study by the Center for Economic Policy Research, or C.E.P.R., in London says the best way to ease imbalances would be for Asian governments, the United States and the European Union to coordinate policy.

It says that while Asia needs to make changes, the U.S. also has to save more and cut spending.

One example of such coordination was the Plaza Accord of 1985. An agreement by Japan, the U.S., Britain, Germany and France allowed the yen to appreciate against the dollar, helping the U.S. cut its trade deficit and begin a period of growth.

But Professor Park of Seoul National University, who is one the authors of the C.E.P.R. study, said no coordination is likely any time soon. He says that is primarily because China is wary of making drastic changes to its managed currency, and the United States feels small changes are not enough.

This story was first broadcast on the English news program,VOA News Now. For other Focus reports click here.

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