'Geofinancial' shift in power balance

Conventional analyses of international relations often refer to the geopolitical power balance. Our Asia correspondent Harvey Stockwin examines a subdivision of the overall balance of power -- the fast-changing "geofinancial" distribution of foreign exchange reserves.

HONG KONG (JP): In the past few weeks, as waves of speculation have successively washed against the Thai baht, Philippine peso, Malaysian ringgit, Indonesian rupiah and Singapore dollar in the global financial arena, one obvious target has been avoided: the Hong Kong dollar.

The Southeast Asian currencies were "attacked" in part because some ASEAN nations operated too rigid a link with the U.S. dollar in their exchange rates.

Yet the Hong Kong dollar is even more firmly pegged to the U.S. dollar than the Southeast Asian currencies. It is only allowed to "float" within a very narrow band, about HK$7.80 to one U.S. dollar. The three private banks which issue the currency notes -- the Bank of China, the Hong Kong and Shanghai Bank, and the Chartered Bank -- have to pay the Hong Kong Monetary Authority (HMA) one U.S. dollar for every HK dollar that they issue.

In Southeast Asia, which is politically stable at the moment, the speculative waves have forced the central banks to loosen their pegs and allow a more flexible float.

Yet in Hong Kong, still politically uncertain in the wake of the resumption of Chinese sovereignty, while the speculative tide has been anticipated, it has not yet materialized.

One reason for this has been the obvious readiness of the HMA to confront any such challenge. At the slightest sign of any such speculative waves heading in Hong Kong's direction, overnight lending rates are quickly raised. If the relatively fixed currency peg were to be held, by raising interest rates to whatever level is necessary, speculators could easily lose their shirts by betting against the Hong Kong dollar.

Behind this financial realpolitik lies another little noticed reality: there has been a marked "geofinancial" shift in the balance of monetary power.

It is not merely that Hong Kong, with a mere six million inhabitants, has the fifth-largest foreign exchange reserves in the world. The four nations of what is often referred to as Greater China possess a tidal wave of their own -- no less than US$374 billion, repeat billion, in foreign exchange reserves, according to the latest available figures.

However, Japan still possesses the largest reserves of any nation, US$222 billion as of June 1997. This is largely a result of its continuing and substantial trade surpluses, themselves in part the product of persistent mercantilist reflexes. The fact that there is no easy link between massive foreign exchange reserves and prosperity is born out by the ongoing slump in Japan's economic fortunes.

But China now comes in second, with a whopping US$121 billion in foreign exchange reserves as of July 1997. Beijing also leans toward mercantilist policies in regard to foreign trade. Like Japan in relation to its market, so China in relation to its market has yet to fully implement the policy dictum to "open up to the outside world". Beijing has also begun to run large trade surpluses, too, notably with the United States. (There is even speculation that China's surplus in trade with the U.S. may soon exceed Japan's).

China's sizable foreign exchange nest egg has been built up despite, or because of, the Chinese yuan not yet being a freely convertible currency.

The Hong Kong dollar is freely convertible. Mercantilist reflexes have never been cultivated in the former British colony. It is as completely open as any economy can be. As a result, Hong Kong often runs trade deficits. Yet it now possesses the fifth- largest (up from seventh) foreign exchange reserves, with US$82 billion at the end of June 1997, when Hong Kong ceased to be a British colony.

Beijing never said "thank you" to the British for exceeding the target by over 300 percent. But a few years ago, China lengthily negotiated, demanding that the British leave US$25 billion in the kitty when their sovereignty ended.

Hong Kong's jump from seventh to fifth comes about because the foreign exchange reserves of the Land Fund, now managed by the HMA in a separate account, have been added to the HMA-held foreign currency assets of US$69.7 billion.

By itself, Hong Kong, which as a Special Administrative Region, will continue to manage its reserves quite separately from China, is well placed to defend its dollar against speculative attacks. Together with China, which has indicated it will help defend the Hong Kong dollar if need be, the two parts of reunified China possesses reserves of over US$200 billion.

The raison d'etre of such a defense is quite simple: the Hong Kong dollar peg is essentially a political exchange rate. The HK$7.80-to-US$1 peg was put in place in 1983 when confidence rapidly declined in the then widely fluctuating floating rate. Were the peg to now succumb to speculative attack, the loss of Hong Kong confidence could be ruinous to the territory's prosperity.

Meanwhile, the two other Chinese-majority states, while both are separate sovereign governments in their own right, together they add another US$171 billion to "Greater China's" US$374 billion. Taiwan ranks third in the world, with US$90 billion as of May 1997, while Singapore, with US$81 billion and a much smaller population, has reserves only slightly less than those of Hong Kong.

Whether one calculates on the basis of Greater China's US$374 billion, or on the basis of East Asia's foreign exchange assets (including Japan, excluding Singapore) of US$515 billion, these foreign exchange figures obviously indicate a noteworthy tilt in the geostrategic balance of global financial power.

Clearly, China has the financial capacity to make the yuan a freely convertible currency, should it choose to do so. Almost certainly it will have to take this step before it will be admitted to the World Trade Organization.

Were the yuan freely convertible, the growing size of China's trade surpluses and of its foreign exchange reserves would, or should, be forcing the yuan to appreciate. Such a development would be clearly in Southeast Asia's interest.

On the one hand, the recent de facto devaluations of Southeast Asian currencies have helped to increase ASEAN export competitiveness vis-a-vis China. On the other, an appreciation of the yuan would give a further assist in this regard, making China's products slightly more expensive in the global marketplace.

So far, the evidence available in Hong Kong suggests that Beijing can use its reserves to prevent the yuan from increasing in value. The current Chinese aim appears to be to try to keep the yuan at the rate of 8.29 to the U.S. dollar.

Taiwan, on the other hand, has not used its reserves to keep its NT dollar from declining. To the contrary, by not intervening to sustain the currency at its current value, as it could easily have done, the Taiwan banking authorities have allowed the NT dollar to decline below NT$28 to the U.S. dollar for the first time in nine years, in order to keep pace with the Southeast Asian devaluations. Similarly, Singapore could have used its huge reserves to keep its dollar from declining at all but has instead allowed it to drift downwards to keep pace with its neighbors.

Thus, while the vast reserves of Greater China might be theoretically seen as a reason for all four currencies strengthening in value, that is not in fact happening.

Meanwhile, China's large reserves of US$121 billion also indicate a miscalculation being made by politicians and businesspeople in many influential nations.

Increasingly, they are basing policy on the expectation of selling more to the huge and mythical Chinese market. If non- Chinese dreams determined events, then China would be running massive trade deficits with the outside world.

China's growing trade surpluses and foreign exchange reserves suggest that it is more relevant, in the real world, to focus on China's huge productive capacity, and its ability to export cheaply to the huge, and actual, global market.

Window A: Behind this financial realpolitik lies another little noticed reality: there has been a marked "geofinancial" shift in the balance of monetary power.

Window B: Clearly, China has the financial capacity to make the yuan a freely convertible currency, should it choose to do so. Almost certainly it will have to take this step before it will be admitted to the World Trade Organization.