'Geofinancial' shift in power balance

'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.