Wednesday, September 03, 2008

The Won Collapse

One of the more interesting developments in recent months is the sharp decline in the value of the South Korean won. Last year, buying a U.S. dollar required slightly more than 900 won, buying a yuan required 120 won and a yen 7.5 won. Now a U.S. dollar costs 1148 won, a yuan roughly 170 won and a yen costs 10.5 won. This week alone, the won is down roughly 5%.

There are several reasons for this decline. First, the sharp increase in the cost of imported oil has wiped out South Korea's previous trade- and current account surpluses. This means that after having previously been able to manage a net capital outflow, Korea must now attract a net capital inflow, which for the reasons described below has been easier said than done.

Secondly, as is reported in this post on the naked capitalism blog, there are increasing worries about the quality of Korea's foreign reserves. The Bank of Korea has much of its reserves in Mortgage backed securities issued by Fannie Mae and Freddie Mac, and so the increasing market distrust of the value of these securities are also increasing market distrust of the won.

And the bearish sentiment created by these events are further eroding market confidence in the won and by extension won denominated assets, creating a self-reinforcing vicious spiral of the kind I explained here.


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