The phenomenon where the exchange rate rises despite an increase in dollar inflows from an export boom is because the market is preemptively reflecting future demand for dollar outflows.
Imagine this: guests are flocking to a shop you run, and a massive amount of money is coming in every day. Strangely, however, when you open the shop’s safe, the money is dwindling. What on earth is happening?
The situation recently unfolding in the South Korean foreign exchange market is exactly like this. Exports are booming and there are plenty of dollars in the market, but the ‘exchange rate’—the value of the won needed to buy those dollars—is actually soaring. Even the Bank of Korea has described the situation as “poverty amidst plenty,” highlighting how difficult it is to understand [Source 2].
Why is this important?
A high exchange rate means that we have to pay more won to buy American goods or acquire dollars [Source 7]. In other words, the practical purchasing power of our citizens may be declining. Recently, the possibility of the KRW/USD exchange rate exceeding 1600 won has been cautiously raised, placing a burden on the overall economy [Source 1]. For ordinary citizens preparing for overseas travel or frequently consuming imported goods, a rising exchange rate leads directly to a felt increase in prices, making it an issue that must be closely watched.
Put simply: Why does the exchange rate rise when there are many dollars?
Why does this strange phenomenon occur? Simply put, exchange rates react far more sensitively to ‘how much people will want dollars in the future’ than to the amount of dollars in our hands right now.
I will explain this with two metaphors.
First, ‘predicting wedding guests.’ Just because there are many guests at a wedding hall today doesn’t guarantee there will always be many guests in the future, right? The market pays more attention to the ‘promise of the future’—that more dollars will leak out for overseas investment or settlements later—than to the ‘look of today’ where many dollars are coming in from exports right now. In other words, the foreign exchange market reads the confirmed mid-to-long-term dollar outflow promises in advance and judges that dollars will become scarce, leading to high demand from those wanting to buy dollars early [Source 8].
Second, ‘a water purifier with a full filter.’ While export companies earn many dollars, an equivalent amount of funds looking to invest overseas (such as ‘Seohak Ants’) or corporate demand for settlements are soaking up those dollars. In fact, there is an analysis that even a mere 3% increase in overseas investment above the average level tends to raise the KRW/USD exchange rate by about 0.7 percentage points [Source 3].
Current situation: An exchange rate deviated from the equilibrium
The average KRW/USD exchange rate over the past 10 years was approximately 1200 won [Source 13]. The current exchange rate level can be seen as having deviated significantly from this long-term equilibrium average [Source 13].
The foreign exchange authorities are also in a difficult position. If they intervene in the market and release dollars simply because there are many of them, it could end up depleting foreign exchange reserves and only giving foreigners the opportunity to buy dollars at a cheaper price [Source 1]. Therefore, the authorities are focusing on ‘micro-adjustments’ to moderate the rate of increase rather than large-scale intervention [Source 1].
What will happen in the future?
Experts say that exchange rates tend to eventually return to their averages in the long run [Source 13]. However, for now, coupled with the overall trend of dollar strength, the upward trend does not seem likely to break easily [Source 12]. The market is even leaving open the possibility of the KRW/USD exchange rate breaking through 1600 won, keeping tensions high [Source 1]. It is now a time when careful investment strategies are needed, while closely examining external factors that will affect the value of the dollar, such as changes in the trade environment and the U.S. interest rate stance.
An exchange rate is like a ‘body temperature’ that shows the health of our economy. The current high exchange rate might be a fever the Korean economy is suffering from, or perhaps it is a signal of a larger structural change to come. The best response we can have is not to be swayed by every single digit of the exchange rate, but to try to understand the hidden flow of the economy behind it.
MindTickleBytes’ AI Reporter Perspective
An exchange rate is not just a phenomenon where numbers rise and fall, but a compass that shows how market participants view the future of our economy. The current situation of a high exchange rate simultaneously reflects the external challenges and structural changes our economy is facing. Even seemingly complex economic indicators are ultimately hidden within the flow of the dollars and won we use. Don’t think of economic news as too difficult. Simply taking a closer look at what changes are happening within the vast flow will give you great power in understanding the economy.
References
- Even though we earn so many dollars… exchange rates go even higher : Nate News
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[Why is the exchange rate rising even though there are many dollars in the foreign exchange funding market? Blog (Details) News/Data Bank of Korea Website](https://www.bok.or.kr/portal/bbs/B0000347/view.do?nttId=10095828&menuNo=201106) - The won that isn’t doing well even after earning dollars… The ‘puzzle’ solved by the Bank of Korea - Financial News
- Exchange rate - Namuwiki
- Export boom but exchange rate explosion? KRW/USD exchange rate, won depreciation, Korean foreign exchange market…
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[The KRW/USD exchange rate has risen for 5 consecutive days, soaring to the 1,547 won level. Newneek](https://newneek.co/@newneek/article/42045) -
[“KRW/USD exchange rate is at too high a level… beware of dollar hoarding” Chosun Ilbo](https://www.chosun.com/economy/stock-finance/2024/12/17/RKVPCJCWIRFEZHAHR364I6UQ4Q/)
- Dollars are scarce but the value of the won is rising
- The exchange rate is rising even though there is an abundance of dollars
- Exports are sluggish, causing dollars to decrease
- Interest rate hikes by the foreign exchange authorities
- Dollar outflows scheduled for the mid-to-long term
- Reduction in dollar investments by domestic companies
- Around 1000 won
- Around 1200 won
- Around 1500 won