The flipside of the Asian crisis

Former prop trader and now London-based co-head of global fixed income and currency at GSAM, Philip Moffit runs one of the world's most successful forex funds. Here he gives his views on Asian currencies:

Some central banks are your clients, and you regularly talk to them. Do you have a sense the central banks in Asia are still moving out of dollars and into euros?

Moffit: That's hard to know, because they say something, but you never know whether they've done it. As a fund manager you don't necessarily know what your clients do. We get asked to help the central banks with some ideas but they don't necessarily tell us it's part of a strategic shift. Even when they appoint us to run money they don't give us any insights either.

It appears - from a market observation - that the trend is continuing. The central banks are continuing to build euro reserves at the expense of dollar reserves, but I don't know for sure. What I do know is that the level of reserves is going up very steadily and because the reserves are going up, just to keep their asset allocation stable, they need to be buying European as well as dollar assets.

There is a theory that we are entering a period of structural dollar weakness and possibly something more serious, with books being published such as 'The Dollar Crisis'. What's your view?

There are elements of that line of reasoning that are quite right. Analysts tend to buy into it. The US is like a company with a poor balance sheet. It has a current account deficit, which is like negative cashflow for a company, and that used to be funded by equity, which was quite a reliable way to fund it. Increasingly it is being funded by short term debt and a lot of that short term debt is being held by Asian central banks. The balance sheet is not only weak but it is getting weaker.

At the same time in Europe and in Asia, the quality of the balance sheet is improving and the cashflow is turning more and more positive and as a result the assets look more attractive. Usually when you have a weak balance sheet getting weaker and you compare it to a strong balance sheet getting stronger, the weak balance sheet will offer a premium to attract funds. But in the market place right now the US gives you lower interest rates than Europe, Taiwan, Korea. So the US is a bad credit paying less than a good credit.

To that extent the dollar should be in a long term downtrend. Does that mean it is going to become a crisis, I don't know.

If the renminbi became convertible tomorrow, would you buy it?

If it became convertible tomorrow we would be inclined to buy it, however we believe this is an unlikely scenario. Should this conversion occur we would of course assess the situation to determine the appropriate course of action. I am of the view that the next big move in currencies will be an appreciation of the Asian currencies.

I used to always think that the Hong Kong dollar would go down, now I think the Asian currencies will go up and the Hong Kong dollar will remain stable with a depreciating dollar.

There are two arguments about the renminbi, both of which I like. One is the Fred Hu argument. This is that the currency is undervalued and should go up. A lot of trade data supports that. The other argument is from Frank Wong at Bank of America in Taiwan who is of the opinion that there is a current account surplus, but when the capital account gets opened up, the quality of the banking system is so bad, that it will lead to a wall of money coming out. Both of which may be right.

Historically, when controls are lifted, the first response is an appreciation, because the trade flows are real and they are there. The capital flows will pick up only when there are opportunities and products. You obviously have some rich people who are prepared for this and ready to go. But the vast majority of people who hold savings need a mechanism to transfer renminbi into another currency. So my guess is we get appreciation and then over time as the capital flow picks up, a depreciation.

My current concern is what I term "lazy talk". When you go to London or the US, everybody thinks that the Asian countries are about five miles apart and have the same economies, and that they operate the same way. What worries me is that as more and more people think through the logic of a renminbi and Asian currency appreciation, it becomes a lazy, fashionable trade and lazy investors get involved, who don't really know why. So we'll get a lot of speculative money washing around in systems which are a bit rigid. And then someone will turn up on Bloomberg with a Korean name and a government connection and will say Korean won overvalued and everyone will run for the exits at the same time.

So what worries me about Asia, is that the logic is powerful but I am concerned about the market dynamic.

The yen and the won are very highly correlated. Do you think that is going to change?

The circumstance in which it might change is if we are wrong and the US economy picks up and is really strong, then Korea will be a bigger beneficiary of that than Japan and that might be enough for the won to appreciate against the yen. But unless that happens, the Koreans and Taiwanese holding the levels of their currencies and waiting to see what the Japanese and Chinese do.

Where do you think the Korean won will appreciate to in the next couple of years?

Let's says renminbi and yen appreciate 10%, then the won is going to be 10% stronger. I feel they will all be pretty much the same. I am confident that within two years we are going to have a big adjustment. But I don't know whether it's going to be in 3 months or 18 months.

Is this the flip side of the Asian crisis, where all the Asia currencies devalued?

Yes, and the central banks are trying to restrain the natural appreciation of their currencies. And if this keeps going for 18 months and the central banks in Taiwan and Korea keep intervening and they intervene by selling their currency, and their currency ends up with the banks and the banks end up with surplus liquidity, it becomes a different version of 1997. That money has to go somewhere. It's either going to go into bonds, equities or real estate. And so you are going to create asset price inflation somewhere in the system. That's what I fear.