Taiwan’s carry trade blowup means bigger dollar trouble

Shuli Ren, Bloomberg

In a week of tributes to Warren Buffett, here’s one from me, in the form of stealing one of his best aphorisms: Only when the tide goes out do you discover who’s been swimming naked.

The currency market is getting a view of that just as traders question the dollar’s dominance and whether the greenback is in a structural decline. Taiwan is among the first left exposed. Its dollar rose as much as 5% against the US currency on Monday, the most since 1988, and has rallied about 8% this year.

Fingers have pointed to idiosyncratic factors, such as thin market liquidity and speculation that Washington asked the island to lift the value of its currency as part of a trade deal, which authorities have denied. Traders may have been spooked by South Korea’s acknowledgement in late April that the exchange rate was one of the four major items to be discussed in future trade talks with the White House. And it’s no secret that President Donald Trump wants a weaker dollar.

As Asians liquidate their dollar assets and repatriate the proceeds, the unwind can be chaotic. However, that Taiwan’s currency extended its rally despite the central bank’s strenuous effort to calm markets points to something more structural.

Wealthy, export-oriented Taiwan, for one thing, is engaged in a massive carry trade. In recent years, the domestic life insurance industry, a big business that is estimated to hold assets equivalent to 140% of gross domestic product, found that it could profitably borrow locally and shovel the proceeds into US dollars.

Life insurance companies invest close to 70% of their money in foreign assets, but 83% of their funding is in the Taiwan dollar, according to Bank of America Merrill Lynch. Meanwhile, their exchange rate risks aren’t fully hedged, averaging only 65% in the fourth quarter.

Taiwanese life insurers are by no means the only ones swimming naked. Foreign investors from G-10 countries alone have about $13.7 trillion in unhedged US assets, UBS Group AG estimates. Global asset managers are also exposed because of their long-held belief in US exceptionalism and a strong dollar, which Trump is inadvertently breaking along with the global trade order.

Asian nations, in particular, are offering the first look at an ugly carry-trade unwind. Just like Taiwan, they’re export oriented and have hoarded a lot of dollars. The Hong Kong Monetary Authority, for instance, is spending an unprecedented HK$60.5 billion ($7.8 billion) to purchase US currency to defend its peg. Central banks with a big savings glut, such as South Korea, Singapore and Malaysia, may also need to scramble to avoid the sudden and violent appreciation of their currencies.

Indeed, there’s a lot of selling pressure in Asia. A recent Bloomberg survey of 18 Chinese exporters showed that they were worried about keeping the dollar and have converted their holdings into yuan. Gold’s improbable rally this year, especially during Asia’s trading hours, further showcases how nervous people are toward the US currency. You can’t blame them. In a paper published last November, Stephen Miran, chair of Trump’s Council of Economic Advisers, mentioned dollar “overvaluation” 10 times.

As the Taiwan currency’s outsized moves show, the global foreign-exchange market has become deeply unstable. Trump changes his tariff stance on a daily basis, but the damage is done. The great dollar unwind has arrived. It’s no longer precious, but pressured. [Abridged]

Courtesy Bloomberg/Shuli Ren