On Dec. 19, South Korea announced plans for a new fee on bank transactions. The goal was to reduce speculation that was pushing its currency, the won, up in value. But Korean officials are wasting their time. These measures won’t be enough to stop the won from appreciating even more.
After all, we continue to see similar policies fail across the globe. World currencies are spiking as low interest rates and the widening money supply in the United States and Japan force investors to search for higher yields elsewhere.
Increasing foreign taxes or introducing new fees is a standard way for a country to deal with a strongly appreciating currency. The idea is to make it more costly for investors to buy and hold its cash.
Yet in country after country, attempts to apply these currency brakes have failed miserably.
Consider Brazil. Portfolio managers love Brazil’s 10.75% interest rates. By purchasing Brazilian bonds, the managers are essentially going long the Brazilian currency. And as a result, the Brazilian real has strengthened against the US dollar, rising by 10% in 2010.
By October, Brazilian officials had had enough. They decided to deter further gains in the country’s currency by raising taxes on foreign investments in fixed-income instruments. The core rate tripled from 2% to 6%.
Despite this, the Brazilian currency has continued to strengthen against the US dollar. It currently sits at an exchange rate of 1.6973 – 2.1% stronger since the decision.
And Brazil isn’t alone. Other countries in Latin America and Asia have tried to restrict gains in their own currencies. You probably know about China’s measures to keep its yuan stable, but do you know about Thailand’s currency woes?
Thailand’s exports have soared to their highest level in almost two decades, accelerating to 28.5% in November 2010. Overall the country is expected to see a 7.5% economic expansion for all of 2010.
Of course, record expansion spurs rapid currency appreciation. So in October, Thai officials removed a 15% tax exemption on income made from the country’s bonds for foreigners. Shortly after the announcement, the Thai baht actually appreciated by another 1.3%.
In fact, for 2010, the baht was one of the strongest performers for the Asian region – strengthening by a little over 10% against the US dollar – second only to the Japanese yen. Furthermore, the exchange rate continues to remain near the strongest levels since just before 1997’s Asian financial crisis.
So, if history has told us anything, it’s that foreign tax policy matters very little when it comes to speculation in a currency. Solid growth prospects and higher yields will always attract investors and outweigh any temporary tax policy that a government can enact.
For the South Korean won, this means that further appreciation is inevitable as long as regional strength continues to churn and the economy expands.
South Korean manufacturing activity expanded at the fastest rate in seven months in December. At the same time, exports rose by 23% compared to activity in December 2009 – a value of a little over $44 billion. Overall the South Korean economy expanded by 6.1% in 2010.
Seoul’s central bankers are trying to slow the pace of growth – raising rates twice last year. Now, the 2.5% benchmark interest rate doesn’t compare to higher rates offered in Brazil, but it’s still higher than anything you’ll see in the United States.
So don’t be surprised that the won has already jumped 8% against the US dollar since May 2010. And with the country’s great growth and attractive interest rates, don’t expect Korean intervention to slow the won’s rise for very long, either.
There’s Still Time for the Korean Won originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today’s markets. Its been called “the most entertaining read of the day.”