Korea: On Verge of a Currency Crisis?

The news of a possible investment by the Korean Development Bank in Lehman is overshadowing far more important developments, at least as far as most Koreans are concerned. The won is on a rapid slide, in a worrying parallel to the Asian currency crisis of 1997, and some other currencies in the region are under stress as well.

As the Standard reports (hat tip reader Saboor):

The won fell 2.5 percent to 1,116.00 against the dollar. The Korean government is “seriously concerned” about the decline…

Indicators show the South Korean economy is in its worst shape since the Asian financial crisis, finance minister Kang Man Soo told a parliamentary session yesterday.

South Korea posted a net capital outflow of US$5.77 billion (HK$45 billion) in July, the largest since December 1997. However, Kang insisted the current economic situation is different from that of 1997, especially the level of foreign debt.

The Philippine peso fell to its lowest level for a year after oil prices rose, increasing the nation’s demand for dollars to pay for the commodity. The currency declined 0.9 percent to 46.32 versus the dollar.

Taiwan’s currency fell to a six-month low on speculation its central bank will seek a weaker currency to support exports. The New Taiwan dollar dropped as much as 0.4 percent to NT$31.65 against the US dollar.

“The trend still points to weaker Asian currencies,” said Christy Tan, a Singapore- based strategist at Bank of America.

“What’s dragging not just Taiwan, but the rest of the region, is the fact that growth is slowing while inflation is still staying firm. Shoring up growth is gaining priority.”

India’s rupee hit a 17-month low after data showed a fourth straight month of net foreign fund outflow from the stock market. The Singapore dollar weakened 0.6 percent and the Thai baht 0.2 percent.

The UK Times linked Korea’s woes to its Fannie and Freddie holdings:
The deepening woes at Fannie Mae and Freddie Mac, badly stretched central bank reserves and a losing battle to support the won are pushing South Korea towards a full-blown currency crisis this month, analysts have said.

Heavy investment by the Korean Government in Fannie, Freddie and other US-related agency bonds has left a potentially huge liquidity problem – perhaps $50 billion (£27.4 billion) – in the foreign reserve portfolio. Some believe that Seoul might have no ammunition left to prevent a significant flight from the won. Fruitless currency intervention by South Korea – increasingly desperate-looking verbal and financial measures to fight the market trend – cost about $20 billion in July alone….
A large part of Korea’s foreign reserves are not government bonds but the kind of US-based mortgage-related bonds that once looked so solid. Depending on how the Fannie and Freddie situation develops, a significant portion of Korea’s forex reserves could turn out to be extremely illiquid, leaving the country ever more vulnerable to external shock.

“The coverage ratio may in reality be not as comfortable as the authorities would like, meaning they have less with which to defend the currency,” said one senior Asia-based economist.

In other words, one of Korea’s last ditch measures to defend its currency would be to sell its remaining Freddie and Fannie debt, but the lack of liquidity argues against that.

The fall in oil prices should in theory help reduce inflationary stresses, but since traders have used the dollar as the anti-oil trade, the appreciation of the dollar means that the relief in energy costs is offset to a considerable degree by the currency fall against the dollar.

A report in the English language version of Chosunilbo gives a sense of the local mood (hat tip reader Saboor):

Rumors of an impending financial crisis in September are sweeping through Korea’s financial markets. On Monday, the first day of the month, the Korean stock market dropped more than 4 percent to the lowest in a year and 6 months, while the Korean currency weakened past the W1,100 barrier against the U.S. dollar for the first time in three years and 10 months…..

The government and financial experts say there is almost no chance of a crisis in Korea, but market players link various economic data with the rumored September crisis and the sense of uncertainty leading to actual decline. Lee Jong-woo, managing director of HMC Investment Securities, said nothing out of the ordinary happened on the stock market on Monday. “Investors unloaded their stock holdings due to predictions that share prices would fall further on Tuesday: it was psychological uncertainties that led to the sell-off,” he said.

The main reason behind Monday’s panic was the September crisis rumor, which refused to go away despite government efforts to calm jitters. Stoking them was a scenario where W8 trillion (US$1=W1,118) worth of foreign investment in bonds maturing in September would exit the Korean market at once, further undermining the won and leading to a string of bankruptcies in financial institutions.

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  1. Anonymous

    not mentioned as much in MSM as the US/UK/mediterranean bubbles but Korea had a ginormous housing bubble as well (gee, big surprise with EZ $$$$).

    Once a cash/carry economy with respect to big-ticket items and property, Korea’s consumers are over-leveraged, facing decreased exports to US, EU, China and hit by high commodity prices.

    Korea + UK = future of US?

    time will tell.


  2. Matt Dubuque

    In a HYPERDEFLATIONARY burst, Henry Kaufman states the only strategy is to invest in the safest and highest quality bonds you can find.

    We are witnessing the absolute liquidation of the world’s financial system, albeit in slow motion.

    Gold, commodities, real estate, corporate bonds and stocks are being liquidated.

    The bull market in Treasuries gathers pace. Flight to quality.

    So much for the scenario that the Fed was lowering interest rates too quickly….

    Matt Dubuque

  3. Anonymous

    It worries me a bit to read about all this currency intervention as a means of improving the economy because it seems to me that the only real value a currency has is in representing real goods and services, and my suspicion is that if central banks keep tinkering with currencies to the point that people lose faith in that relationship then we’ll find ourselves face to face with a crisis which eclipses all others.

  4. Jesse

    I think the KDB – LEH deal has been a dead man walking for at least a week when the government guy came out and said that after seeing the books the Korean government nixed the purchase deal because LEH was decidedly more insolvent than they had thought. It might come back in some smaller form if Min has enough turf clout but he’s the only person in Korea that seems to favor the deal publicly, and he might even have a conflict of interest being a recent LEH employee. But who can say for sure? Deals are funny things.

    I don’t think this one gets done without a JPM-BSC like backstop or some other maneuver by Fuld to get the toxic crap off the books.

  5. Anonymous

    Upon reading this blog it seems every post is about the imminent collapse of financial institutions, devaluations of currency, manipulation of government statistics, etc.
    This leads me to believe most power brokers are prepping their yachts to escape to somewhere.

    And where would that be? What countries are fiscally sound and free from the worry of imminent apocalypse? Who’s doing it right?


  6. doc holiday

    10 year Treasury yield continues to fall, which is a warning!!! It hit 3.742 today!

    Is that related to a global currency rebalance after the CDO/SIV-like subprime meltdown; or, is this a Lehman-like event playing out like markets before Bear Stearns crash/bailout in March — with CDS spiking, yields crashing, stocks oscillating with VIX, etc. There is systemic instability generating harmonic waves, like a tsunami wave building offshore… regardless of poetry, I'm in The Hussman Camp on this and think we see stocks plunge on a global basis.

    FYI old news (April 29): The South Korean won had its largest decline in almost two weeks after Finance Minister Lee Hun Jai said it was “overvalued,'' raising concern the central bank will sell the currency to protect exporter earnings.

    Korea's government yesterday said it will auction 1 trillion won ($861 million) of bonds in May to raise funds it can sell to curb the currency's 2.3 percent rally against the dollar this year. The country has sold 5 trillion won of the bonds this year, including 1 trillion won this month.

    “Our exchange rate is a little bit overvalued,'' said Lee in an interview. “The exchange-rate level should be decided by the demand and supply,'' so “even though the level is somewhat overvalued, it will be better to keep at the level depending on the market movement.''

    The won fell 0.8 percent to 1,165.15 against the dollar as of 10:16 a.m. Seoul time, its biggest drop since April 16, according to Seoul Money Brokerage Services Ltd.

    Now>> one won = 1,129.6


  7. Anonymous

    To Anon at 3:54,

    You raise an interesting point. All the econ/finance blogs I read are uniformly doom and gloom. Everyone seems to be predicting further worldwide collapse in housing, financial markets, etc, etc, etc.

    Now, maybe we are entering some sort of worldwide depression. But I remember how everyone was doom and gloom in 2002 and that was the bottom. I don’t expect 2008 to be the bottom (I’m thinking 2009 or 2010), but the amount of negativity out there seems a bit overdone. When everyone is leaning one way, it’s sometimes the smart move to be contrarian.

    Good luck, Y’all

  8. Anonymous

    FYI: The South Korean won dropped to another four-year low against the dollar, even though the government warned it had the ability to stem the currency weakness, with investors concerned about a flight of capital from Asia’s fourth-largest economy.
    Equity markets fell to their lowest since 2006 amid talk of a looming crisis.
    The sharp economic slowdown that began in the United States and hit developed markets in Europe and Japan now appeared to be tightening its hold on emerging markets.
    “Political uncertainty in Asia is dollar supportive by default,” said Sharada Selvanathan, currency strategist at BNP Paribas in Hong Kong.
    “Global growth is slowing which is hurting exports, inflation remains persistent, central banks need to raise interest rates – but the last thing a government about to fall wants is higher interest rates. It’s a vicious cycle,” she said.
    Irene Cheung, head of Asia local markets research for ABN AMRO in Singapore, said the $1 trillion of capital that has flowed into Asia since 2001 is now at risk of trickling out of the region.
    South Korea, Indonesia, Malaysia and even China could see outflows because of local currency weakness, further tightening of global liquidity and economic deterioration.
    “We note the risk of a potential reflow of capital out of Asia, not just on the back of a dollar rebound but also growing pressure among global banks to repatriate capital toward (the) year end,” she said in a research note.

  9. doc holiday

    So with global deflation (or perhaps just inflation) what happens to the cash that will flow out of Asia? Where will it go and why? Treasury bond yields are headed lower, stocks are headed lower, house prices going lower, commodities lower, mortgage rates higher, so where will that extra cash chase yield/performance in this liquidity trap — in regard to $1 Trillion morphing out of Asia? What happens here, an instant dollar bubble, where virtual cash spins around the globe without any connection to reality?

  10. doc holiday

    Ok one last spastic thought:

    Let’s say, cash somehow heads towards mortgage rates, i.e, banks lending at higher rates, how will that work, as ARMs reset or rates are set for longer term notes at higher rates — that seems like it would trigger more foreclosures and then increase lower home values? I seriously don’t see where cash can run to, without burning up! I think we see that tsunami of cash float to the bottom of the ocean like Titanic! Keep your life preserves close by!

  11. Anonymous

    Investors are retreating from securities backed by credit card loans following a slowdown in consumer spending, which accounts for more than two-thirds of the U.S. economy. Delinquencies are rising as Americans rely more on the debt to cover expenses because falling home values are causing banks to restrict access to home-equity lines of credit.

    “The focus is on the weakened consumer,” Christopher Sullivan, chief investment officer at United Nations Federal Credit Union in New York, said today in a telephone interview. “The consumer is severely pinched, and we are likely to see this trend in consumer ABS products continue.”

    More than $358 billion of credit card asset-backed securities were outstanding as of the first quarter, according to the Securities Industry and Financial Markets Association. Spreads have surged as the credit crunch has damped investor appetite for all but the safest U.S. government debt.

  12. leftback

    Matt Dubuque is correct. If you watch Treasuries, you will see rates dropping rapidly – you will also be watching the smart money leaving the building.

    One of the reasons that the $ is getting stronger by the day is that a lot of the money that was invested in emerging markets is coming home now, and you can see the results in the Shanghai, Mumbai and Seoul markets.

    I cannot rule out another small pump and dump stock market rally in the US, maybe from the 50DMA at SPX 1300 up to the 200DMA at 1360, but you already know how this movie’s gonna end, dontcha?

  13. Mara

    Agree with doc holiday, where could the cash go? If it’s to higher mortgage rates, it sounds good in theory, but when not enough people have good credit or could qualify, it’s a vapor-ware dream. There’s a cost to exiting one’s positions in a hurry, and then there’s a greater risk in getting into high return-rate investments (since AAA now means you’re not going out of business this week, maybe). A trillion dollars liquidating out is like a 400lb fat lady trying to get out of the back seat of a volkswagen with modesty and decorum. There’s a long duration of time and expending of effort to try and reach that goal. Perhaps, if it proves too arduous (or revealingly unsavory), she’d rather come up with an excuse to stay there.

  14. Jesse

    Where did the cash go in the Crash of 1929. Short term Treasuries and the long Bond.

    Bonds themselves crashed pretty badly about two years after the Stock Market Crash with the devaluation of the dollar by 50 percent (against gold).

  15. doc holiday

    Check this out:

    February 2008
    Federal Reserve Bank of Dallas
    Accounting For the Bond-Yield Conundrum

    With this in mind, it’s worthwhile to review some changes in the economy and financial markets that might be relevant to the conundrum. In particular, market participants have cited the following factors as lowering risk premiums, putting downward pressure on long-term interest rates.

    Foreign official purchases. Many market participants have suggested that substantial increases in foreign official purchases of U.S. Treasury securities in recent years have substantially depressed long-term Treasury yields.[2] In particular, Asian central banks built up their holdings of foreign reserves and kept their currency values low relative to the dollar to boost exports to the U.S.

    Faced with a rapid accumulation of dollar assets from record-high trade surpluses, Asian central banks invested many of these reserves in U.S. Treasury bonds, exerting downward pressure on Treasury yields (Chart 3). Some economists estimate such pressures on the 10-year Treasury yield at 40 to 120 basis points.

    Increased demand by pension funds. Some analysts argue that declining bond yields may partly owe to higher demand for longer-duration Treasury securities as a result of proposed corporate pension reforms.

    In particular, U.S. pension funds might be required to match the maturities of their assets and liabilities. This concern may have encouraged them to increase their holdings of longer-duration Treasuries ahead of any regulatory changes, suppressing long-term Treasury yields. Some analysts also cite U.K. pension reforms, which have been associated with unusually low yields on British bonds.

    Decreased macroeconomic uncertainty. Because long-term bond yields are closely related to short-term interest rates and other macroeconomic fundamentals (both present and expected), declines in macroeconomic uncertainty since the early 1980s may have put downward pressure on long-term interest rates.

    The Great Moderation of the American business cycle, as described by Fed Chairman Ben Bernanke, has been linked to decreased uncertainty about inflation, real growth and real interest rates.

    >> We now have a 10-year Treasury Yield at almost a 50 year low, which of course seems to be pushing Treasury prices higher, thus if more cash floods into that safety zone, who benefits from unloading overvalued Treasuries? Maybe someone should ask Gross, or a bond expert or someone that has too much Fannie or LEH??

  16. doc holiday

    Well, whadya know? I need to add two more cents here:

    Top Bond Investors Show Interest in GSE Capital Raising with Treasury Involvement

    >> Reuters points out Pimco’s preference, which is directed toward a straight preferred stock offering – where Gross “would buy preferred stock subject to significant Treasury participation and an attractive yield.” Fuss, on the other hand, objects Gross’ assertion by countering that the common stock approach is “a long-term call”. What Fuss, who in my view is fundamentally a ‘maestro’ in bond investing and anything about him is certainly worth reading, suggests instead, is an offering of convertible debentures.

    >> How nice, the Treasury yield is crashing, while Treasury sets up a bailout for fannie… uh huh!

  17. Anonymous

    re: ***where could the cash go?***

    in addition to everything mentioned above: long bond, etc. ….try CHF and JPY.

    IMO, gold isn’t necessarily safe in a deflationary environment.

    As always YMMV.

  18. Dean

    I think we all very well know what’s the antidote for crisis, financial or otherwise. Admitting it though, in the face of peer pressure, it’s an entirely different matter.

    O.k. let’s pretend for a while that the elusive “safe harbor” (albeit under our noses) doesn’t exist. I am 100% certain that it will come into focus fairly soon.

  19. Matt Dubuque

    Doc Holliday, seems like you are missing a very basic and fundamental point when you say:

    “what happens to the cash that will flow out of Asia? Where will it go and why? TREASURY BOND YIELDS ARE HEADED LOWER, stocks are headed lower, house prices going lower, commodities lower, mortgage rates higher, so where will that extra cash chase yield/performance”

    Treasury bond yields are going LOWER because everyone is snatching them up, the ULTIMATE HYPERDEFLATION edge.

    The PRICE goes up on these bonds when their YIELD goes down….

    Buying Treasuries on margin right now is the REAL gravy train.

    Their prices are SOARING (and their yields are plummeting).

    It’s necessary to understand the inverse relationship between yield and price on bonds….

    Very basic and VERY important

    The money you refer to is going into Treasuries. That is WHY the yield is plunging.

    This inverse relationship between price and yield is not a matter of controversy. It’s a fundamental tenet of finance.

    A vote of confidence by the markets in the policies of the Fed.

    If you believe in markets that is….
    Matt Dubuque

  20. Matt Dubuque

    By NO MEANS do I see an imminent crash, although I certainly can’t rule it out and the bottom could well be in 2010, 2011 or beyond.

    But for me the strong probabilities are tending, for a variety of reasons, for a “SUPERPROMPT, CRITICAL EXCURSION (engineering parlance to describe a nuclear meltdown) before the end of February 2009, when the disjunct occurs, the “diffusion jump” as we say in derivatives modeling parlance.

    The Fed is trying its best to make this necessary dramatic repricing of risk as orderly as possible.

    They are giving us all time to prepare for what’s coming down hard.

    I’m grateful to them for that.

    The additional time they are providing cuts down on the collateral damage.

    We have time to prepare for ourselves and our families. We just need to get organized for the great tsunami.

    Matt Dubuque

  21. doc holiday


    I need an animal photo here…, as this may be on the verge.. of a history FYI, that may fit in??

    Monetary Power and PoliticalAutonomy: Exchange RatePolicymaking in Follower States

    Even under the most aggressive pressure from American Treasury officials, especially from Secretary John Connally, Canada refused to support the US attempt to shore up the Bretton Woods system in the negotiations following President Nixon’s decision to suspend the official convertibility of the US dollar on August 15, 1971. Rasminsky recalled the key negotiating session vividly:Connally was very rude. We had to float, and I told him privately that we were not his problem. We were not draining US gold reserves, since we were holding much of our foreign reserve in the form of non-marketable T-bills. He began yelling about Canada always having its hand out for one thing or another but never being willing to help, and I raised my voice in anger. He stormed out of the room. In a public session later, Connally asked [IMF Managing Director ]Schweitzer if Canada was contravening the Articles. He said yes. But we immediately intervened to ask Schweitzer if he thought that under the circumstances it would be possible for Canada to fix a durable par value. He said no. This probably helped put him in hot water with Connally. 10 After the Smithsonian Agreement was announced in December 1971, Canada’s unwillingness to participate in the re-pegging exercise was publicly and bluntly attacked by Paul Volcker of the U.S.Treasury and by Arthur Burns, then Chairmen of the Federal Reserve. Canada, according to Burns in 1972, “had not been prepared to be helpful to the USA in its time of need” (Muirhead 1999, 294)….

  22. a

    Let me get on my conspiracy hat here! Is this a reason why Korea is interested in buying Lehman? It could then swap its agencies for treasuries, since Lehman is a primary dealer. Otherwise it may have to unload a lot of agencies in a difficult market.

  23. Anonymous

    Korea is a country that produces real wealth….cars, ships, electronics etc….
    Imagine a country like Spain….with a subsidiary of Volkswagen making the cars, that is thinking about moving production to Eastern Europe, and no ships, and no electronics….completely dependent on tourists from Northern Europe…who are staying at home increasingly….Let’s see who hits the wall first…Spain or South Korea….my money is on Spain…and then you will see a real crisis….Spanish politicians will cause a collapse in the value of the Euro…

  24. Kady

    I agree that treasury yields are low b/c there is mass flight to safety, but I don’t understand why everyone believes that treasuries are safe.

    Given the Fed’s bailout of Bear and their clear intention to bail out the GSEs, it seems misguided to think that the US dollar can remain strong or that US treasuries themselves are no loaded w/ risk.

    Maybe that’s just me.

  25. Gargamel

    Anything that you have to watch daily to see if it is holding value isn’t a good form of wealth storage. Save your money in gold and silver the only true money.

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