07-05-2025
Why the Asian currency blowup matters
You can't make an omelette without breaking some eggs. And you can't make a new global trading order without breaking a few things in financial markets.
The big picture: A stunning surge in the value of the Taiwanese dollar and other Asian currencies over the last week is a vivid example of how the Trump administration's break from a decades-old system of global commerce will cause collateral damage along the way.
The world is highly exposed to the U.S. dollar, so a shifting perception of the U.S. role in the world economy could have rapid and unpredictable effects across global markets.
The flip side of persistent U.S. trade deficits is that many other countries accumulate massive stockpiles of Treasury bonds and other U.S. assets. To the extent that President Trump is serious about trying to reduce the trade deficit, it implies major disruption to asset markets as well.
Exactly how, when, and where that plays out is anybody's guess. We're not aware of anyone who predicted a currency market flare-up driven by Taiwanese life insurance this time last week!
Catch up quick: The Taiwanese dollar surged 10% relative to the U.S. dollar between last Thursday and Monday. It has partially receded since, but that's still a much bigger and faster move than is usually seen in currency markets.
It reflected the nation's life insurance and pension funds rushing en masse to shift away from U.S.-issued debt and to hedge their exposure to the dollar.
Taiwan's huge stockpile of U.S. assets reflects its longtime trade surplus. As it sells semiconductors and other goods to American firms, it must somehow recycle the dollars it earns.
The shift came against the backdrop of a steadily weakening dollar over the last month, which made the firms eager to protect against the risk of losses from their dollar-denominated assets falling further. But everyone rushing to the door at the same time made the situation worse.
Between the lines: It's not uncommon for moderate economic and policy shifts to be magnified by crowded trades and financial market positions unwinding. The global financial system routinely turns small sparks into big conflagrations.
It is worth remembering that, amid volatile trade policy and loose talk about purported "Mar-a-Lago Accords" or other efforts to reset global currency and debt arrangements.
Flashback: Following Trump's April 2 tariff announcement, Treasury bonds fell sharply, a move that analysts partly attributed to the unwinding of the "basis trade" — in which hedge funds profit from the gap between Treasury securities and futures contracts tied to those bonds.
In the fall of 2022, the U.K. government released a deficit-busting fiscal plan that caused the value of its bonds to fall, exacerbated by pension funds facing a cascade of margin calls and forced selling.
A 1998 default on Russian bonds was the key catalyst for the collapse of the massive hedge fund Long Term Capital Management and East Asian currency crises.
The bottom line: These first gyrations in currency and asset markets triggered by U.S. policy swings aren't enough to have much impact on the economy. But they're probably not the last.
