[Dollar Dominance]② The Dollar's Strength Lies in Enduring the Current Account Deficit... Sensitive to Economic Slumps in Korea, China, and Japan Currencies

Won-Dollar Exchange Rate Nears 1,350 Won High
Yuan and Yen Also Plunge... Only Dollar Strengthens
Clear Economic Slowdown in Korea, China, and Japan Compared to US
China-Led 'De-Dollarization' Discussions Lose Momentum

As the value of the US dollar continues its relentless rise, the currencies of Korea, China, and Japan are falling helplessly. Earlier this year, concerns about a US economic recession and expectations of a Federal Reserve (Fed) pivot (a shift in monetary policy direction) led to a weak dollar and strong Asian currencies, but in less than a year, the situation has completely reversed. With the Chinese economy also showing signs of weakness amid a strong dollar, analysts predict that the China-centered 'de-dollarization' movement will lose momentum.

Won-Dollar Exchange Rate Hits Annual High... Powerless Against Strong Dollar

Recently, the values of the Korean won, Chinese yuan, and Japanese yen against the dollar have shown a clear downward trend. The won-dollar exchange rate surged by 13 won during trading on the 26th to 1,349.5 won, surpassing the annual high of 1,343.0 won recorded on the 17th of last month, and opened at 1,355 won on the 27th, up another 6.5 won. The yen-dollar exchange rate fell below 149 yen, the lowest this year, approaching the psychological resistance level of 150 yen. The yuan-dollar exchange rate has remained above 7.31 yuan, maintaining the '7 handle' (yuan-dollar exchange rate surpassing 7 yuan per dollar) status for over four months.

The dollar's strength against the Korean won, Chinese yuan, and Japanese yen reflects contrasting economic conditions. According to the US Department of Commerce, the US trade deficit in July was $65 billion, significantly reduced from $71.7 billion in the same month last year. Typically, when the currencies of China, Japan, and Korea?major US trading partners?depreciate against the dollar, the US trade deficit worsens significantly, but recently, despite the strong dollar phase, the US trade deficit with these countries has remained similar.

This indicates that the US economy can endure a strong dollar while continuing its tight monetary policy aimed at price stability. A-min Kwon, a researcher at NH Investment & Securities, explained, "China's surplus is recession-driven due to weak domestic demand, and other major US trading partners, excluding China, have seen a significant decline in their current account balance relative to GDP. Since China, Germany, and Japan have similar or reduced trade surpluses with the US, the US is not in a position to warn these countries about currency depreciation."

Professor Sam-mo Kang of Dongguk University's Department of Economics said, "The US inflation rate has recently stabilized in the 3% range, and economic growth is expected to be higher than Korea's, which explains the dollar's strength against the won and other currencies. Many forecasts suggest the US economy will continue to recover next year, so the strong dollar is likely to persist."

Weak Economies of Korea, China, and Japan... Unable to Counter Strong Dollar

On the other hand, Korea, China, and Japan are struggling to maintain tightening policies due to sluggish economies. Despite the Korea-US interest rate differential widening to a historic high of 2 percentage points, the Bank of Korea held the base rate steady for six consecutive meetings until the Monetary Policy Committee meeting on the 24th of last month. Although committee members have indicated the possibility of one more rate hike depending on inflation and the Fed's policy direction, the market views an actual rate increase as unlikely given Korea's economic growth rate has fallen to the 1% range.

Japan faces a similar situation. The yen's value has fallen to its lowest level this year due to the widening US-Japan interest rate gap, but the Bank of Japan continues its ultra-loose monetary policy. Some analysts predict that Japan may soon abandon its yield curve control (YCC) policy due to the adverse effects of excessive yen depreciation, but considering Japan's government debt-to-GDP ratio is 263%, the highest among developed countries, any rate hikes will likely be limited due to the burden of government bond interest payments.

As a super-aged society, Japan plans to increase social security spending and significantly boost defense spending, likely financing these through government bond issuance. Even a 1 percentage point rate hike would impose a massive interest burden on the Japanese government. The Bank of Korea also forecasted in a report released on the 13th of last month that Japan's monetary policy would "maintain an accommodative stance for a considerable period."

The situation is similar for the Chinese yuan. Chinese authorities are injecting massive liquidity and implementing various stimulus measures to boost economic recovery, but the real estate market remains sluggish. With the interest rate gap widening with the US and economic weakness compounding, the yuan faces increasing downward pressure. Despite the People's Bank of China issuing statements several times to signal its intention to defend the yuan's weakness, the effect has been limited so far.

China's Weakness Dampens 'De-dollarization' Movement

As the dollar continues to strengthen, the debate over 'de-dollarization,' which threatens the dollar's status as the global reserve currency, is also fading. China has supported de-dollarization since February last year when the US excluded Russia's currency from the Society for Worldwide Interbank Financial Telecommunication (SWIFT) payment network after Russia's invasion of Ukraine, criticizing the US for weaponizing the dollar. China has accelerated the internationalization of the yuan, agreeing to settle trade with Brazil and Argentina in yuan instead of dollars.

Last month, the addition of six new countries, including Saudi Arabia, to the China-led BRICS group reignited discussions on de-dollarization. Saudi Arabia and Iran, as oil-producing countries, carry significant weight. Many oil-producing countries peg their currencies to the dollar, which plays a major role in maintaining the dollar's reserve currency status. If these countries increase yuan usage, the dollar's influence could weaken. The Dutch ING Bank analyzed last month that "the dollar is being displaced by various currencies, including the yuan."

However, the recent significant slowdown in China's economy has weakened the significance of de-dollarization discussions. For the yuan to become a reserve currency, China would need to tolerate a persistent current account deficit like the US, but the recent crisis exposed vulnerabilities in China's domestic markets such as real estate, making this difficult to sustain. According to SWIFT, the yuan's share of global payments remains just over 3%, far behind the dollar's 42.02% presence.

Of course, the US economy could falter due to high oil prices and a federal government 'shutdown,' but it is difficult to see the yuan growing enough to threaten the dollar's status anytime soon. Professor Kang said, "China's large share in global trade gives the yuan some advantages as a reserve currency, but issues of international trust will limit this. Compared to the US, Europe, and Japan, China lags in financial markets and regulation, making it unlikely that the yuan will become a reserve currency in the short term."