The Taiwanese Dollar Shock: How a 6.6% Currency Move Reveals Hidden Global Financial Flows

Brad Setser explains why the Taiwanese dollar's dramatic appreciation exposes the fragility of decades-old currency arrangements and massive unhedged dollar exposure.

Key Takeaways

• The Taiwanese dollar appreciated 6.6% in just three days, representing a seismic shift for one of the world's most stable currencies
• Taiwanese life insurers hold approximately $200 billion in unhedged US dollar assets, creating massive currency risk when the dollar weakens
• The move reflects broader Asian currency weakness that made appreciation inevitable, with starting points at crisis-era levels for many currencies
• Taiwan's central bank chose not to aggressively intervene, possibly to teach insurers risk management lessons or due to US pressure over currency manipulation concerns
• This represents a potential template for coordinated Asian currency appreciation as part of broader trade deal negotiations
• The shift will rotate demand away from US corporate bonds (where Taiwanese insurers are major buyers) toward US treasuries (preferred by central banks)
• China's decision not to depreciate the yuan in response to 154% tariffs removed a key obstacle to broader Asian currency appreciation
• Taiwan's 15% of GDP current account surplus has created unsustainable imbalances requiring eventual correction through currency moves or fiscal expansion

Timeline Overview

• 00:00–15:00 — Introduction to the dramatic Taiwanese dollar move; context from famous 2019 OddLots episode about Taiwanese life insurers and their secret hedge book with the central bank
• 15:00–30:00 — Current state of Taiwanese flows; life insurers still hold massive unhedged dollar positions due to expensive hedging costs from US rate hikes
• 30:00–45:00 — Broader dollar weakness post-April 2nd explained by Asian currencies starting from extremely weak levels; China's yuan stability removing depreciation pressure
• 45:00–60:00 — Taiwan central bank intervention capabilities and constraints; potential US pressure over currency manipulation concerns; risk management considerations for insurers
• 60:00–75:00 — Implications for coordinated Asian currency appreciation; Taiwan's massive current account surplus requiring eventual rebalancing through fiscal policy or currency moves
• 75:00–90:00 — Market impacts on US corporate bonds, treasuries, and rate volatility; rotation from private insurer demand to central bank buying patterns

The Unraveling of Currency Stability

The Taiwanese dollar's 6.6% appreciation in three days shattered decades of carefully managed stability, revealing the fragility of arrangements that made massive unhedged dollar positions appear safe for institutional investors.

• Taiwan runs "one of the biggest current account surpluses in the world" at "close to 15% of Taiwan's GDP over hundred billion a year" requiring someone in the economy to accumulate foreign assets on a massive scale
• Life insurers became the primary vehicle for this capital export, building up portfolios where they "put about 2/3 of their total assets in foreign bonds" with most exposure to US dollar assets
• The famous 2019 OddLots investigation revealed 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"
• Current unhedged exposure reaches approximately "$200 billion, which is 15 to 20% of their assets" according to estimates by Brad Setser and former JP Morgan strategist Josh Younger
• Hedging became prohibitively expensive as "the US hiked rates in 2022 and 2023" making "the cost of hedging" a "function of the differential between Taiwanese short-term rates and US dollar short-term rates"
• Insurance regulators compounded the problem by allowing "lifers to substitute a foreign exchange volatility reserve for some hedging" enabling institutions to reduce hedge ratios when currency risk was actually increasing

Perfect Storm Conditions for Currency Appreciation

Multiple factors converged to create ideal conditions for dramatic Asian currency appreciation, with the Taiwanese dollar move representing broader regional dynamics rather than isolated local factors.

• Asian currencies started from crisis-level weakness with "the yen at 145" being "an incredibly weak yen" and "the Korean won was at 1450, the level it reached during the Korean financial crisis and during the global financial crisis"
• The Taiwanese dollar was similarly "on the weak side of its long-term range" before the recent move, creating substantial room for appreciation without reaching historically strong levels
• China's crucial policy decision not to respond to "draconian tariffs the 154% tariff" by "depreciating the yuan" removed the primary anchor that typically prevented other Asian currencies from strengthening
• This created a regional dynamic where "China didn't respond that the yuan didn't depreciate" allowing other Asian currencies to appreciate without competitive disadvantage
• Market sentiment shifted based on "news flow that is suggestive that there's at least some chance there'll be an agreement or even in the absence of an agreement a decision to pull back some of the US tariffs on China"
• The combination of weak starting points, Chinese yuan stability, and improving sentiment created "the backdrop for this recent move" across multiple Asian currencies simultaneously

Central Bank Intervention Calculus

Taiwan's central bank possesses unlimited theoretical capacity to prevent currency appreciation but chose restraint for strategic reasons related to both domestic financial stability and international political considerations.

• Unlike defending against depreciation where central banks can "run out of foreign exchange," when "trying to prevent your currency from appreciating" there's "really no intrinsic limit to how much foreign exchange a central bank can accumulate"
• The Taiwan central bank already holds "close to 600 billion of dollars" representing "close to 100% of Taiwan's GDP in foreign exchange reserves" with "no intrinsic limit on how high that could go"
• The bank chose to "smooth some of the moves" rather than stop them entirely, possibly because "they thought the life insurance industry had gotten a little bit too aggressive" and needed to "learn a useful lesson in risk management"
• US political pressure may have influenced restraint since "the US Treasury is preparing its next foreign exchange report" and "Peter Navarro has long thought that the Taiwanese dollar was undervalued"
• Currency manipulation concerns created sensitivity where the central bank "may have been a little bit reluctant to just put an absolute block on this move and in the process draw attention to the fact that Taiwan's currency is heavily managed"
• The intervention strategy balances allowing market forces to operate while preventing disorderly moves that could destabilize the insurance sector or broader financial system

Coordinated Asian Appreciation Strategy

The Taiwanese dollar move potentially represents the beginning of coordinated Asian currency appreciation that could serve multiple policy objectives for both regional governments and US trade negotiators.

• Taiwan's situation illustrates broader regional imbalances where "running a 15% of GDP current account surplus in perpetuity effectively has meant that Taiwan has been overpaying for US dollar bonds for the past 15 years"
• This creates "an ever bigger forward-looking financial loss from the inevitable currency move because the Taiwan dollar is by any measure incredibly weak"
• The logical policy response involves both currency appreciation and "more aggressive fiscal policy, more investment in their own defense, and a bigger and more generous social safety net"
• Regional coordination makes sense since "Taiwan, Korea, Japan all prefer to appreciate when all their currencies are going up together" avoiding competitive disadvantages
• For US trade policy, coordinated appreciation could achieve rebalancing goals more effectively than tariffs since "the most effective way to bring the US trade deficit down is just to get the dollar weaken"
• Scott Bessent could potentially "engineer a coordinated appreciation of all Asian currencies" as part of broader trade negotiations that go beyond traditional trade agreements

Market Rotation and Bond Demand Shifts

The currency move will fundamentally alter global bond market dynamics as different institutional players respond to changing incentives and risk profiles.

• Taiwanese life insurers are "particularly important" for "long-dated US corporate bonds 20 year plus investment grade corporates" and "dollar bonds issued by relatively high-grade emerging markets and Asian issuers"
• Recent years already showed reduced demand as "Taiwanese lifers have not been big buyers of so-called callable bonds" and "that particular bid has sort of disappeared"
• If insurers "reduce their dollar book" markets will see "less demand for corporate bonds including some in particular corners of the market where they're very important"
• Central bank intervention creates a rotation because when banks "buy dollars" they "tend to be the player that is least inclined to buy corporate debt" and "most inclined just to plow that money into the Treasury market"
• The counterintuitive result is that "central bank demand for treasuries tends to be very correlated with dollar weakness" as intervention activity supports government bond markets
• Potential hedging facilities could allow "the lifers to hedge pretty much directly with the central bank" using existing "repo facility for foreign central banks" to manage dollar exposure without destabilizing sales

Long-term Structural Implications

The Taiwanese dollar move exposes fundamental structural imbalances in global capital flows that require comprehensive solutions beyond currency adjustments alone.

• Taiwan's current account surplus stems from TSMC's dominant position where "their export position won't be enormously impacted by moves in the Taiwan dollar" given technological advantages in semiconductor manufacturing
• Fiscal policy remains constrained where "the government doesn't run much of a fiscal deficit" and "doesn't spend very much on defense either" despite obvious needs for both domestic investment and security spending
• The insurance sector requires structural reform since the current model of using life insurance products as savings vehicles creates permanent pressure for foreign asset accumulation
• Global rebalancing requires coordination since Taiwan's surplus must find counterparts elsewhere, and currency moves alone cannot resolve underlying saving-investment imbalances
• The template established in Taiwan could apply broadly across Asia, where multiple economies run large current account surpluses that create similar foreign exchange accumulation pressures
• Successful resolution requires combining currency flexibility with fiscal expansion and financial sector reforms that reduce dependence on foreign asset accumulation for economic stability

Summary

The Taiwanese dollar's dramatic appreciation represents more than a currency correction—it signals the potential unraveling of decades-old arrangements that enabled massive unhedged foreign exchange exposures while maintaining artificial currency stability. The move reveals how post-April 2nd dynamics have shifted global capital flows in ways that stock market indices fail to capture, with implications for everything from US corporate bond demand to coordinated Asian currency policy.

Practical Implications

• For Investors: Recognize that currency moves can create massive value shifts in ways that equity market stability masks, particularly for institutions with large unhedged foreign exchange exposures
• For Policymakers: Understand that coordinated Asian currency appreciation could achieve trade rebalancing more effectively than tariffs while avoiding the economic disruption of trade barriers
• For Central Banks: Consider how intervention strategies must balance market stability with allowing necessary adjustments to unsustainable imbalances accumulated over decades
• For Financial Institutions: Reevaluate hedging strategies and currency risk management, particularly as interest rate differentials make hedging costs more volatile and potentially prohibitive
• For Bond Investors: Prepare for rotation in demand patterns as private institutional buyers (like insurers) potentially reduce exposure while central bank buyers increase activity through intervention
• For Analysts: Pay greater attention to global capital flows and currency markets, which may signal important structural changes that don't immediately appear in equity market performance
• For Taiwan Specifically: Develop comprehensive rebalancing strategy combining currency flexibility, fiscal expansion, and financial sector reforms to address unsustainable external surpluses and foreign asset accumulation