Brad Setser on the Big Surge in the Taiwanese Dollar

Brad Setser (0:02)

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Joe Weisenthal (0:18)

Hello, and welcome to another episode of the Odd Lots Podcast. I'm Joe Weisenthal.

Tracy Alloway (0:23)

And I'm Tracy Alloway.

Joe Weisenthal (0:24)

Tracy, sometimes our old random episodes on just random things end up being kind of relevant.

Tracy Alloway (0:32)

What do you mean sometimes? What do you mean random? All of our episodes, each of them are like our children. They're each special and relevant in their own way. That's what I say.

Joe Weisenthal (0:41)

You're right, they're all special. I would say they're all special in their own way. Some of them probably have more relevance to others. This used to not even be our full-time job. We just found interesting things, sometimes connected to the news, sometimes not. But I remember in 2019, the first time I noticed people talking about Odd Lots before the pandemic was an episode we did on Taiwanese life insurance companies.

Tracy Alloway (1:07)

That's right. And I guess the reason this episode kind of went viral or became a thing was because of the framing. We sort of framed it as a financial market murder mystery almost, or sort of whodunit in global financial flows. And I guess you don't get many of those. You still don't get many of those. We should do more of them. But people definitely got into this one and definitely still remember it.

Joe Weisenthal (1:30)

Definitely still remember it, definitely get into it. So the basic gist was that it was sort of well known, obviously, that Taiwanese life insurance, which is this huge investing savings product in Taiwan, that they were a major purchaser of US treasuries, which of course leaves the companies potentially at risk for currency slippage, but that the Central Bank in Taiwan was revealed in the whodunit as the entity sort of providing a hedge of sorts, such that this was an economic safe trade for the life insurance companies. And of course, there's only one person we could have ever been talking to who would have been able to explain this whole phenomenon.

Tracy Alloway (2:10)

That's right. And of course, we're going to be speaking to them again, because it's a new month. And in fact, one of the things we've seen happening, the big story so far this month, is the move in the Taiwanese dollar. So we've seen this massive appreciating move in the Taiwanese dollar against the US dollar. I think just this morning alone, we're recording on Monday, May 5th. It was up something like five percent just in a day against the US dollar.

Joe Weisenthal (2:36)

It's up two and a half percent. I think it's up like five percent total in two days.

Tracy Alloway (2:42)

Five percent total in two days, sorry. But still, for a currency that tends to be fairly stable and boring, this is a huge deal. So there's three certainties in financial life. There's death taxes and the idea that the Taiwanese life insurers are going to be buying dollar denominated assets because they can. Because things have remained so stable and so boring for decades now that they can just keep on doing this trade. And then suddenly, out of nowhere, just in the past two days, we've seen this really violent shift in the way things have always been happening in Taiwan. And so we got to talk about it. We definitely got to talk about it with Brad.

Joe Weisenthal (3:23)

We got to talk about it. Actually, I'm looking at this, a three day chart, USDTWD down 6.6% since April 30th. Crazy move. You're right. We got to talk to Brad Setser. He's the one who's been on this story longer than anyone else. Brad Setser, Senior Fellow at the Council on Foreign Relations. Thank you so much for, I don't know, you're coming back for your 15th Odd Lots appearance.

Brad Setser (3:47)

Not quite 15, but it's a lot.

Joe Weisenthal (3:49)

Okay, maybe I'm just exaggerating, but not by much, I don't think, at this point. You know, it's interesting in the post-April 2nd environment, a lot of markets like Treasuries, or just the Treasuries and the stock market have stabilized quite a bit. But the currency does seem to be where the action is. Stepping back up, before we get to the move that we've seen over the last few days, just for the sake of our listeners, give us the sort of top level description of the flows that we see out of Taiwan and the role of the central bank there in making that trade economical for the lifers.

Brad Setser (4:24)

Well, Taiwan runs one of the biggest current account surpluses in the world. It's fluctuated between 10% of Taiwan's GDP and 15% of Taiwan's GDP. It's now on the high side. It's close to 15% of Taiwan's GDP, over $100 billion a year. That is a big sum. And obviously, a current account surplus means that someone in the economy has to on net be accumulating foreign assets. And over time, that entity has shifted from the 10 years after the Asian financial crisis, it was essentially the Central Bank of China, Taiwan Central Bank, accumulating foreign exchange reserves, mostly going into treasuries. At some point, the Central Bank of China said more or less, hey, we've got enough reserves. And maybe they were coming under a little bit of pressure from the US to manage their currency a little bit less. So the Central Bank and the insurance regulator, in a sense, worked together to make it possible for the life insurance industry, which in Taiwan is big, to add to the share of its assets which were in foreign currencies, and to increase the sales of insurance policies so that the insurance industry was growing relative to Taiwan's economy. Combine those two things and the insurers, basically from 2010 to 2020, build up an enormous portfolio of foreign bonds. They put about two-thirds of their total assets in foreign bonds, an enormous share. And as in our famous episode, there was a secret hedge book that offset, let's say a quarter of that exposure with a hedge with the central bank, which wasn't disclosed until 2020