Tag: trade

TWD: An FX whodunnit

The Taiwanese dollar (TWD) soared as much as 8% this month. This would be a colossal move for any currency, but especially for TWD, which usually moves less than 0.5% daily. Folks have been scrambling to figure out who was responsible for this spectacular rally, from exporters to life insurance companies to the central bank.

It’s the balance of payments, stupid. I type this on a laptop made in Taiwan, contributing to the island’s current account surplus of 14% of its GDP. Such a bounty would ordinarily lead to appreciation of TWD, but much of it is recycled back out by life insurance companies (“lifers”) and the central bank buying foreign assets like US Treasuries. What’s more, exporters tend to retain a lot of their proceeds in foreign currency. Altogether, the trifecta of lifers, exporters, and the central bank have been building up an epic long-dollar position for years.

Central bank started selling dollars. The trifecta holding a floor under USD/TWD began to unravel in 2024. In the first half of the year, the central bank sold $9.1 billion of FX reserves — its biggest sale yet. I estimate that since then, they have picked up the pace of selling even further to an average $2 billion per month into March this year.

My own estimate of the central bank intervention amounts

There were clues… Around the time that the central bank began selling dollars, TWD started trading stronger than my framework1 implied (this is all before the big move recently). This outperformance of TWD indicated that the currency was experiencing a regime shift. There is a lesson here: when one’s framework starts to “break down” it is a sign that something is afoot. This discrepancy from the model foreshadowed the 15 sigma move that we saw in early May 2025.

Lifers and exporters were not the first movers… To be clear, over the period that the central bank was selling dollars, insurers were actually reducing USD/TWD hedges (i.e. selling less dollars) and exporter conversion of FX proceeds had fallen to its lowest ever rate (i.e. selling less dollars). So the CBC was the first mover in the trifecta that had been keeping TWD weak until now.

… but they must have piled in. Lifers and exporters had too large a long-dollar position to not take notice of the change at the central bank. Lifers own almost $700 billion in foreign assets, and 60% of this is FX-unhedged. Exporters were holding on to their own mega-pile of dollars. Based on TWD’s historical sensitivity to flows, I estimate that the big move in early May 2025 was enabled by a conversion of around $45 billion going through. There are few parties who can manage such a colossal flow, but lifers and exporters fit the bill.

American scrutiny. So there you have it: the trifecta propping up USD/TWD started unraveling last year when the central bank began selling dollars, leading exporters and lifers to panic-sell dollars this month. But why did the central bank start this? One possible explanation is that they are keen to avoid the ire of the United States, where the Treasury department keep Taiwan on a “monitoring list” of economies whose currency practices merit scrutiny — being on the list is especially hazardous during a trade war. I would have expected the US to give Taiwan a pass, given the latter’s strategic importance, but this is not the first time that Taiwan has reduced FX intervention due to American scrutiny.

Plenty of downside for USD/TWD. Lifers could still sell another $400 billion — around ten times the amount that I estimate went through recently. If expectations for TWD cannot be anchored again, there is plenty of downside for USD/TWD. Until the central bank receives the green light from the US Treasury to buy FX, USD/TWD will be left to the preferences of lifers and exporters. This means that when the dollar is selling off, it will be prone to violent swings.

1In my framework for TWD, I model the currency against historical patterns by key actors including lifers, exporters, and the central bank.

Trump’s tariffs originate in the trade deficit

Trump’s tariffs have captivated the current news cycle and bear major ramifications for the cost of goods, global supply chains, and America’s influence in the world. The goal of his policy is to narrow America’s trade deficit, which he calls a “national emergency”.

A gaping goods deficit. America experienced its first modern goods deficit in 1971, a product of the postwar industrial revival in Europe and Japan. Since then, US demand for foreign merchandise like cars and electronics have ballooned the deficit to $1.2 trillion or 3.7% of GDP in 2024. The goods deficit (blue in the below chart) dwarfs America’s surplus from services, like management consulting and software licenses. Aside from goods, other sources of outflows like foreign aid are also being targeted by Trump scaling back on America’s defense commitments.

Quarterly data; smoothed four quarters

The money does come back eventually… The outflows from America’s goods deficit generally return back to the country via inbound foreign portfolio investment. As a result, the Chinese own 2.8% of outstanding US Treasuries, Koreans own 1.5% of Tesla stock, and so on… We can see this in America’s balance of payments (BOP), which tracks all cross-border flows, visualized in the next chart. US BOP essentially comprises of a wide current account deficit (blue) and large foreign inflows into American stocks and bonds (green).

… But not everyone likes this deal. The administration does not consider America’s BOP dynamic — a current account deficit funded by financial inflows — to be a healthy state of affairs. Robert Lighthizer, the architect of the trade war in the first Trump presidency, describes it as a transfer of wealth to foreigners: “aggressors now own both those assets and the future income of a large segment of the U.S. economy”.

Quarterly data; smoothed four quarters; dollarization includes inflows into US dollar deposit accounts.

What about industrial policy? There are other ways to tackle the good deficit. Tariffs seek to hamper imports. Meanwhile, “industrial policy” or government support of strategic sectors can be used to support exports. But industrial policy, which requires a strong centralized government like China’s, is tricky under America’s fractious political system.

What about a weaker dollar? Another option is to try to weaken the dollar, which would simultaneously support exports and stymie imports. But currency devaluation would carry major geopolitical ramifications for Washington. In any case, whether it is intentional or not, Trump is already pursuing a weaker dollar policy by demanding the Fed cut rates.

Around the same time that the United States experienced its first modern goods deficit in 1971, Nixon upended the international monetary order. He halted the international convertibility of dollars for gold and engineered a devaluation of his currency against those of Germany and Japan. Today’s goods deficit is significantly larger, both in nominal terms and as a share of GDP. It will probably remain a key focus for the White House.

Data from US Bureau of Economic Analysis. Charts produced on Python.