South Korea’s monthly exports crossed the $50 billion mark for the first time in October. Solid demand from the developed world was what drove the country’s performance. Korea has also run a current account surplus for 19 straight months. The country’s foreign-exchange reserves increased to $343.2 billion in October, pushing it into seventh place globally. The recovery in Korea’s economy is looking more stable, and Korea should be commended for this. Such a brilliant achievement, however, may not be the blessing it appears to be.

Some economists have warned of two major risks involved in accumulating large foreign exchange reserves: first, there is an opportunity cost that central banks incur by investing in low-yielding, safe assets with minimal returns; second, the value of the large reserves holdings is vulnerable to changing exchange rates. On top of these drawbacks, there are the currency-war cries among trading partner countries. Lately, for example, the U.S. Treasury Department in a semiannual “currency report” warned the Korean government not to intervene in currency markets. This report is intended to ensure that major trading partners do not use their currencies to gain a competitive edge over U.S. exports. It encouraged the Korean government to limit intervention to “exceptional circumstances of disorderly market conditions.”

The Korean won’s strength should reflect South Korea’s strong economic fundamentals, including a large and growing current-account surplus. And yet Korean policy makers are worried about big gains in the won hurting exports. The won has gained around 7 percent against the dollar since July. The won’s rise was largely driven by massive inflows of foreign capital by investors seeking better returns in South Korea, one of the best-performing emerging economies in Asia.

Korean officials are nervous about the possibility of capital flight when global liquidity dries up. The country was one of the worst-hit during the severe foreign-currency liquidity shortage during the 1997-1998 Asian financial crisis and again during the 2008 global financial crisis. If the markets turn volatile, therefore, the officials will take action to stabilize them.

On the other hand, the U.S. and Japan have pursued quantitative easing to stimulate growth following the global financial crisis. QE amounts to printing money ― it is a deliberate currency-weakening policy. It pushes down interest rates and spills cash abroad in search of higher returns, pushing down the value of the easy-money currency.

The resulting currency weakness threatens a currency war. Emerging economies are struggling to maintain growth as their currencies strengthen against the U.S. dollar and the Japanese yen. For these reasons, emerging economies in Asia are among the loudest objectors to QE by the U.S. and Japan. Although the U.S. criticizes other countries for market intervention, the U.S. insists QE is fully compatible with its international obligations.

The chairman of the Fed, Ben Bernanke, argued that QE has not only helped the U.S. economy grow but also helped the world economy avoid deflation and that it is not a beggar-thy-neighbor policy. However, QE and intervention in foreign exchange markets are both weak-currency policies and they essentially manipulate the value of currencies. What is the difference between QE and foreign exchange market intervention? Both are currency-weakening policies, but QE is intervention in bond markets instead of foreign exchange markets. This means a currency war is underway.

By Lee Chae-woong

Lee Chae-woong is professor emeritus of economics at Sungkyunkwan University, Seoul. ― Ed.