Brad Setser on the Big Surge in the Taiwanese Dollar

Episode Summary

Executive Summary: The episode examines a sharp recent appreciation in the Taiwanese dollar and what it reveals about Taiwan’s massive foreign-asset buildup, especially among life insurers that have long bought dollar bonds with limited hedging. Brad Setser argues the move reflects both a weaker dollar backdrop and pressure on Taiwan’s central bank and insurers to adjust a long-running, risky structure in global capital flows.

Main Topics: Taiwanese life insurers and the global flow “whodunit” (Priority: 5/5): The hosts revisit an earlier Odd Lots episode that framed Taiwanese life insurers’ foreign-asset accumulation as a mystery in global financial flows, highlighting how their buying of U.S. dollar assets became a defining market theme. Sharp appreciation of the Taiwanese dollar (Priority: 5/5): The central current event is the Taiwan dollar’s sudden, unusually large jump versus the U.S. dollar, which the hosts describe as a dramatic break from a long period of stability. How Taiwan’s current account surplus is recycled (Priority: 5/5): Brad Setser explains that Taiwan’s huge current account surplus has historically been recycled into foreign assets via the central bank, then increasingly via life insurers and banks, creating large unhedged dollar exposure. Hedging costs and under-hedged insurer balance sheets (Priority: 4/5): The discussion focuses on why insurers reduced hedges: U.S. rates made hedging expensive, regulators allowed more flexibility, and institutions responded by taking on more currency risk. Why the dollar weakened after April 2 (Priority: 4/5): Setzer argues the broad U.S. dollar decline reflects both extreme prior dollar strength in Asia and China’s choice not to counter tariffs by devaluing the yuan, which set the stage for regional FX moves. Policy choices: central bank intervention, trade negotiations, and rebalancing (Priority: 4/5): The conversation explores how Taiwan might manage appreciation, including smoother central bank intervention, possible hedging facilities, and broader fiscal rebalancing toward domestic demand. Impacts on Treasuries, corporates, and credit markets (Priority: 3/5): Setzer discusses how a shift in Taiwanese buying patterns could reduce demand for corporate bonds and rotate flows back toward Treasuries if the central bank becomes a bigger dollar buyer.

Key Arguments: Taiwan’s current account surplus is enormous—roughly 10% to 15% of GDP—so the economy must keep accumulating foreign assets in some form. Taiwanese life insurers became major holders of foreign bonds, reaching about two-thirds of total assets, with a large share of that exposure unhedged. Hedging became expensive as U.S. short rates rose relative to Taiwan’s, encouraging insurers to reduce hedge ratios and take more FX risk. The Taiwan central bank may be smoothing appreciation rather than fully blocking it, partly because it wants insurers to internalize risk and partly due to U.S. scrutiny of managed currencies. The broader dollar decline since April 2 is explained by a weak starting point for Asian currencies and by China’s choice not to depreciate the yuan in response to tariffs. If Taiwan lets the currency appreciate and uses fiscal policy to support domestic demand, it could reduce long-run financial imbalances and lower systemic risk. A central-bank hedging facility or coordinated policy support could help insurers manage currency risk without forcing the central bank to suppress appreciation. The likely market effect of a weaker insurer bid is less demand for long-duration corporates and some emerging-market/Asian dollar debt, while central-bank intervention could support Treasury demand.

Data Points: Taiwan current account surplus: 10% to 15% of GDP - Setzer says Taiwan has sustained one of the world’s largest current account surpluses. Taiwan current account surplus in dollars: over $100 billion per year - Annual external surplus magnitude cited in the discussion. Insurers’ foreign bonds share: about two-thirds of total assets - Describes the scale of life insurers’ foreign-bond holdings built over 2010–2020. Unhedged insurer book: about $200 billion - Estimate from Setzer and Josh Younger of the life insurers’ unhedged exposure. Unhedged share of assets: 15% to 20% - Relative size of the unhedged book versus insurers’ total assets. Taiwan dollar move over two days: about 5% appreciation - Hosts describe the abrupt strengthening as extraordinary for a normally stable currency. USDTWD move since April 30: down 6.6% - Three-day chart cited during the episode showing the sharp currency move. Taiwan foreign exchange reserves: close to $600 billion - Central bank reserves including off-balance-sheet holdings. Taiwan reserves relative to GDP: close to 100% of Taiwan GDP - Shows the scale of reserve accumulation. Chinese tariffs mentioned: 145% total tariff burden - Setzer references 20% from legacy fentanyl measures and 125% from reciprocal tariffs. Korean won level cited: 1450 - Used as an example of extreme weakness among Asian currencies. Taiwan dollar level cited: around 30, previously near 33 and historically near 28 - Illustrates the currency’s recent move and its longer-term range.

Pivotal Quotes: "Taiwan is just stuffed to the gills with unhedged holdings of dollars and dollar bonds." — Brad Setzer: Summarizing the accumulated currency risk in Taiwan’s financial system. "Hedging was expensive." — Brad Setzer: Explaining why insurers reduced hedge ratios as U.S. rates rose relative to Taiwan rates. "Never let it be said that odd lots is not an agent for change." — Tracy Alloway / Jill Weisenthal: A joking acknowledgment that the earlier episode may have influenced policy disclosure and awareness.

Implications: Taiwan’s currency move may force insurers, regulators, and the central bank to reduce long-standing FX imbalances. If appreciation continues, it could shift global demand away from corporate credit and toward Treasuries, while also advancing broader rebalancing toward domestic spending.