Expectations for Dollar Shortage Relief with US Fed Leadership... Not a Cure-All

Currency Swap Agreement Followed by Exchange Rate Surge During 2008 Financial Crisis
Fundamental Resolution of COVID-19 Issues Needed... Vigilance Essential

US Took Swift Initiative Unlike Financial Crisis
Lee Ju-yeol "Leadership of Key Currency Central Banks... Thanks to Chairman Powell"

[Asia Economy Reporters Eunbyeol Kim and Sehee Jang] With South Korea and the United States abruptly signing a currency swap agreement, the domestic foreign exchange market is being evaluated as having temporarily eased. However, there are concerns that the effect may be short-lived, and some warn that the 'Korea-US currency swap' should not be seen as a cure-all. Since the novel coronavirus disease (COVID-19) has become a pandemic, the fundamental problem cannot be considered resolved unless COVID-19 is brought under control.

◆Like the 2008 Financial Crisis... The Effect May Be Short-Term= "Just because the Korea-US currency swap agreement has been made does not mean all problems are solved." This is a statement from an official at the foreign exchange authorities regarding the recent currency swap agreement. When the Korea-US currency swap was signed on October 30, 2008, the won-dollar exchange rate, which had reached the 1,400 won level, quickly dropped to the 1,250 won level. However, the exchange rate gradually began to rise again and returned to the pre-swap level within about 20 days. In December of that year, the Bank of Korea made three withdrawals from the currency swap, calming the exchange rate again, but by April of the following year, the exchange rate soared to nearly 1,600 won per dollar.

At that time, concerns about the global real economy persisted even after the currency swap agreement, which pushed the exchange rate back up. As major countries such as the United States, Japan, and Europe recorded negative growth rates and risk-averse behavior emerged, a preference for the dollar reappeared.

Even now, amid the COVID-19 pandemic, the world is desperate to secure dollars. The Dollar Index, which shows the value of the dollar against six major currencies, remains above 100 despite the currency swap announcement. Ultimately, if the fundamental problem is not resolved, the Korean foreign exchange market is likely to be seen as a place where foreigners can freely exchange dollars. Especially compared to China, Hong Kong, Singapore, and Malaysia, Korea's openness is higher, which could accelerate dollar outflows.

Yumi Kim, a researcher at Kiwoom Securities, said, "The decline in the won-dollar exchange rate may be short-lived," adding, "For the won to remain strong, the dollar's strength must be limited, and signals that COVID-19 is subsiding must appear." She also evaluated, "Ultimately, confirming the containment of COVID-19 is most important for exchange rate stability, and until specific countermeasures for credit risks related to bad assets in the U.S. emerge, volatility in the won-dollar exchange rate is inevitable."

Bank of Korea Governor Lee Ju-yeol also told reporters on his way to work that day, "This currency swap is intended to alleviate the dollar shortage, and it is a different issue from a financial crisis." He said, "While financial market instability caused by dollar shortages in emerging countries can be prevented from spilling over to the U.S., the Federal Reserve is handling financial crises caused by real economy downturns through other means."

[Image source=Yonhap News]

◆This Time Led by the U.S.... Differences from 2008= However, the situation is not exactly the same as in 2008. During the financial crisis, South Korea requested the currency swap from the U.S., and the U.S. was initially reluctant, but this time the U.S. took the lead. As COVID-19 spread globally, a dollar shortage emerged, and if this situation prolonged, the U.S.'s position as the key currency country could be shaken, prompting the U.S. to act quickly. With market instability such as dollar shortages and rising dollar value appearing in global financial markets, the dollar's function as the key currency is being constrained, and financial market instability in one country is spreading to others, leading to international financial market instability. Therefore, the U.S. judged that it must alleviate the dollar shortage as the key currency country.

Governor Lee said, "The most prominent phenomenon in the current international financial market is risk aversion, and since a dollar shortage has occurred in the international market, the key currency country feels constrained, which is why they stepped in." He added, "This case shows the leadership of the central bank of the key currency country, with the U.S. acting quite swiftly. I am very grateful for Federal Reserve Chairman Jerome Powell's prompt decision-making."

Separately from the currency swap, Governor Lee emphasized that Korea's foreign exchange reserves are at an appropriate level. He evaluated, "Even when applying several criteria to assess the adequacy of foreign exchange reserves, the current level is generally considered appropriate."

Yeo-sam Yoon, a researcher at Meritz Securities, said, "Blocking external shocks with the currency swap was a good choice," advising, "The next task is to control government bond and corporate bond yields, and since large companies' financial conditions are also poor, liquidity in this area should be monitored." He also added, "Some level of safety net is needed for securities companies, which have grown larger than insurance companies."

This content was produced with the assistance of AI translation services.