Asian central banks on Thursday intervened in the currency markets to halt the rise in the value of their currencies against the US dollar, prompted by fear that they could be at a disadvantage in export markets, with China. Also on Thursday, IMF researchers led by their chief economist Olivier Blanchard, asked if the large accumulation of international reserves in many emerging economies over the past decade, mitigated the impact of the financial crisis?

Central banks, which were reported to have bought dollars include South Korea, Hong Kong, Malaysia, Singapore, Taiwan, Thailand, the Philippines and possibly, Indonesia, according to analysts

China has effectively pegged the value of the renminbi to the dollar since July 2008 to protect its exports.

It is also reported that Russia bought as much as $4 billion this week, including $1.4 billion on Thursday.

Despite the intervention, ICE Futures US dollar index, which tracks the American currency against six other major currencies, dipped 0.9 per cent to 75.798, a 14-month low.

The trade-weighted value of the dollar is back at the level it had two years ago.

Since the Asian crisis in 1997, countries have amassed large reserves by keeping their currencies undervalued, as insurance against having to call on the IMF for help. The current leadership of the IMF, under former French finance minister Dominique Strauss-Khan, has a much more enlightened approach to struggling economies than predecessors but it will take time if at all to appreciate that.

Global imbalances - - high reserves in Asia and American chronically in deficit - - are seen as contributors to the economic meltdown as a credit liquidity glut in the mid years of the decade, pushed down long-term interest rates in developed countries.

Asia in effect became the world's banker.

Under political pressure in 2005, China introduced a managed float for its currency and by mid-2008, it had appreciated 20 per against the US dollar.

In a paper in 2008, the US Congressional Budget Office estimated that a 20 per cent revaluation of the renminbi would cause the average price of US imports from China to rise by roughly 7 per cent to 11 per cent if Chinese exporters continued to fully pass through their costs.

In June 2009, a report by the Peterson Institute for International Economics, a Washington-based think tank, said the majority of the 29 currencies it studied needed to appreciate against the dollar, with a large rise especially needed by the Chinese currency.

SEE: Finfacts article Jul 01 2009: China has pegged currency to US dollar since July 2008 to help exporters; Emerging markets expected to keep currencies undervalued as crisis risks recede

IMF researchers say it is hard to tell whether the self-insurance Asian economies were seeking, was successful. On the one hand, most emerging markets weathered the current crisis better than in the past. On the other hand, this could be attributed to the fact that the crisis originated in advanced economies, and to much better macroeconomic policies and frameworks in emerging economies than in the past. Indeed, as the chart below shows, there is no apparent relationship between the amount of reserves held before the crisis (scaled by the size of the economy) and output declines during the crisis. The same holds true when one controls for various relevant factors shaping the effects of the crisis on growth such as trade and financial openness, exposure to falling commodity prices, initial current account imbalances, or other financial vulnerabilities.

Olivier Blanchard, Hamid Faruqee, and Vladimir Klyuev say that in a similar vein, despite large differences in reserves relative to the size of the economy, various measures of market strain behaved in a similar fashion in most emerging markets. They cite the case of Brazil and Mexico - - the two largest Latin American economies. Even though Brazil has much higher reserves than Mexico, even relative to the size of the economy, there has been very little difference in the performance of credit default swap spreads. In fact, while reserve accumulation was halted at the peak of the crisis, surprisingly little was used to defend currencies or alleviate financial strains. Apparently, markets react very nervously to news of reserve declines, no matter how strong the initial position is.

The researchers say, going forward, there may be another round of ratcheting up international reserves in the aftermath of the crisis.

"While understandable, such a reaction could well dampen the recovery, as it would constrain demand in emerging economies even as demand is squeezed in the advanced countries; and it would exacerbate global imbalances. It is worth considering ways of reducing the need for large reserve accumulation. One would hope that private instruments could supplement the IMF’s efforts to provide alternatives to self-insurance, such as new allocations of Special Drawing Rights (SDRs) and the Flexible Credit Line," they conclude.

However, Asian countries will look at the travails of the Baltic republics and wonder. There was no currency crisis in the Asia region although there were some gyrations in value such as the experience of the Indonesian rupiah.

Asia has of course also been spared the huge personal currency risks assumed in Eastern Europe when countries allowed Western European banks to provide housing finance to their citizens in hard currencies.     

IMF Blog: high international reserves

IMF data on international reserves

Finfacts articles Oct 2009:

Gold rises to a new record; Premature to expect end soon to dollar dominance

Dr. Peter Morici: The falling dollar and China’s cries for a global currency