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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.
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 not 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.
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.
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 demand 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 investment 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.
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.
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 of 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. | 
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