Working-Level Korea-U.S. Exchange Rate Talks
Sharp Drop in Won-Dollar Rate to 1,390 Range
Low Likelihood of a Mar-a-Lago Accord Repeat
Limited U.S. Gains from Won Appreciation
The sharp drop in the won-dollar exchange rate is rooted in concerns that, starting with the Milan negotiations between South Korea and the United States, the U.S. will intensify its demands for South Korea to appreciate its currency. There has been persistent speculation that the U.S. will push for a weak-dollar agreement with countries that have large trade surpluses with the U.S. as part of efforts to reduce its trade deficit. The U.S. has argued that the dollar is excessively overvalued and that its chronic trade deficit is a result of the dollar’s structural strength. To support a successful tariff policy, the U.S. claims that a weak-dollar agreement must inevitably follow the imposition of indiscriminate tariffs. However, there are doubts about the feasibility of a weak-dollar agreement, as there are clear limits to reversing the won's trend through intervention by the foreign exchange authorities, and cooperation from large economies such as China and the European Union (EU) is essential.
According to the Ministry of Economy and Finance on May 15, Choi Jiyeong, Deputy Minister for International Economic Affairs, met with Robert Kaproth, U.S. Deputy Assistant Secretary for International Affairs at the Treasury Department, in Milan, Italy, on May 5 during the Asian Development Bank (ADB) Annual Meeting, to hold working-level negotiations on exchange rates. After the heads of finance and trade from South Korea and the U.S. officially began trade talks in Washington on April 25, the departments in charge of exchange rates continued behind-the-scenes consultations via written communication and conference calls, before holding their first face-to-face meeting. A Ministry of Economy and Finance official said, "The two sides listened to each other's opinions and agreed to discuss the scope of future agendas," but avoided specifying the details of the working-level negotiations.
When this news broke, the foreign exchange market was shaken significantly. The won-dollar exchange rate, which had been in the 1,420-won range during the previous night session, fell to the low 1,390-won range, and both the yen and the dollar index also dropped sharply. Later, when the U.S. side responded that "there are no plans to include exchange rate provisions in a trade agreement," the rate rebounded to around 1,405 won. On this day, the won-dollar exchange rate opened down 9.3 won from the previous session and fluctuated in the 1,410-won range in early trading.
For South Korea, significantly appreciating the won would require either raising the benchmark interest rate or selling dollars, but given the domestic economic conditions, both options are nearly impossible. A Ministry of Economy and Finance official said, "There is growing demand for additional interest rate cuts to respond to the economic slowdown." As a result, it is expected that South Korea will inevitably face pressure to use its foreign exchange reserves, with the strong dollar being cited as the problem. As of the end of April, South Korea’s foreign exchange reserves totaled $404.67 billion, much of which is held in U.S. Treasury bonds. The U.S. may target countries such as South Korea, Taiwan, and Japan?nations highly dependent on the U.S. for diplomatic and security reasons?first, pressuring them to appreciate their currencies.
In fact, it was revealed that Taiwan entered into closed-door negotiations with the U.S. on May 1 regarding exchange rate adjustments, causing the value of the Taiwan dollar to surge by over 9% against the U.S. dollar at one point this month. Because Taiwan effectively operates a fixed exchange rate system with strong government control, demand for currency hedging shifted to neighboring Asian currencies such as the Korean won, Singapore dollar, and Chinese yuan. Many observers view the trend of strengthening major Asian currencies, triggered by the sharp rise in the Taiwan dollar, as the start of a second Plaza Accord.
However, both within and outside the government, the consensus is that the likelihood of a weak-dollar agreement similar to the Plaza Accord of 40 years ago (the so-called Mar-a-Lago Accord) being repeated is extremely low. For a Mar-a-Lago Accord to be possible, it would be necessary to persuade both the EU, which has a large economy, and China, which is the main target of the U.S., but the EU is not intervening in the foreign exchange market, and it is highly unlikely that China, as a rival nation, would comply with U.S. demands.
It is also difficult for the U.S. to build momentum for such a push, given that the practical benefits of a stronger won for the U.S. are limited. The foreign exchange market has grown so large that unlimited intervention by the authorities is unlikely to have a significant medium- to long-term effect. In addition, considering the steady domestic demand for dollars from sources such as offshore won liquidity, the National Pension Service, and individual investors investing overseas, the scope for trend adjustment in the exchange rate through intervention is very limited. It is reported that the Ministry of Economy and Finance explained in previous high-level talks that it would be difficult to achieve the won appreciation targets sought by the U.S. under these circumstances.
If the market is shaken and the dollar falls sharply, demand for U.S. Treasury bonds?America’s Achilles’ heel?would disappear, which is another major concern for the U.S. The U.S. is under enormous debt pressure, with federal government debt approaching 124% of GDP as of the end of last year. The U.S. spent $881.7 billion just on interest payments for Treasury bonds last year, more than its total defense spending of $874.1 billion for the same period. This debt pressure is at the root of the U.S.'s tariff gambit. A government official said, "There are many obstacles to realizing an exchange rate adjustment agreement like the Plaza Accord of 40 years ago," and added, "The U.S. will likely seek gradual exchange rate adjustments to reduce the trade deficit while maintaining the dollar-centered international financial system."
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