What the Taiwan Dollar is Telling Us
The first domino in a wider market move?
You might have noticed some fireworks in the currency markets lately - specifically the dramatic plunge in the US Dollar versus the New Taiwan Dollar (USD/TWD). This wasn't just typical FX volatility - it was a move that if you go purely of the financial market implied math (which we know is only right until its wrong and blows everything up) then this event should never have happened in the history of the universe. It was a significant move that flashed warning signs about broader shifts happening under the surface of global markets.
Coming after the market weirdness following the hypothetical "Liberation Day" tariffs in April, this sharp TWD strength deserves a closer look. Let's break down what's likely driving it and what it might mean.
The Fundamental Engine: Taiwan's Trade Powerhouse
At its core, a huge part of this story is Taiwan's massive and growing trade surplus with the United States. Driven largely by the seemingly insatiable global demand for advanced semiconductors from giants like TSMC ($TSM), Taiwan is exporting far more to the US than it imports. For 2024, this goods trade surplus reportedly clocked in around US$74 billion, a significant jump from the previous year.
Basic economics tells you what happens next: all those US dollars earned by Taiwanese exporters eventually need to be converted back into New Taiwan Dollars (TWD) to pay local costs, salaries, and taxes. More surplus means more USD flowing into Taiwan, creating more demand for TWD and pushing its value higher (meaning USD/TWD goes down).
Adding fuel to this fundamental flow is Taiwan's strong stock market performance. The TAIEX index has largely kept pace with the S&P 500 over the last five years, attracting foreign investment capital which also needs converting into TWD.
The Accelerant: Hedging Headaches and Momentum
But fundamentals aren't the whole story. Financial flows can amplify these moves significantly. Consider Taiwan's large life insurance industry. These institutions hold a huge chunk of their assets overseas – estimates suggest around 70%, often denominated in US dollars (like US Treasuries). Their liabilities, however (what they owe policyholders), are mostly in TWD.
When the TWD strengthens rapidly against the USD, the value of those USD assets shrinks when measured in TWD, creating potentially large balance sheet losses for the insurers. To protect themselves (to hedge), they are incentivized to sell USD and buy TWD, ironically adding even more upward pressure on the Taiwan dollar. It becomes a self-perpetuating feedback loop.
Throw in market momentum – traders jumping on the trend, perhaps speculating that Asian currencies are being allowed to strengthen to help with US trade negotiations – and you get the recipe for the kind of sharp move we just witnessed.
The Broader Context: USD Weakness and Central Bank Action
This wasn't happening in a vacuum. While the TWD move was extreme, similar (though more muted) strengthening was seen against the USD in other Asian exporter currencies like the Japanese Yen, Hong Kong Dollar and the Chinese Yuan.
Crucially, this coincided with the period after "Liberation Day" where we saw US Treasury yields rising (as discussed in my previous market reaction post. Rising yields alongside a weakening dollar often suggest broad selling pressure on US assets.
We saw tangible evidence of this pressure in interventions. Taiwan's central bank reportedly stepped into the market not necessarily to stop the TWD's rise entirely, but to smooth the volatility caused by the rush. Meanwhile, the Hong Kong Monetary Authority (HKMA) was forced to intervene heavily (its highest daily intervention) – selling US dollars and buying Hong Kong dollars to prevent the HKD from appreciating past the strong end of its permitted band (7.75). This is significant intervention, highlighting the underlying USD weakness.
So, What Does This All Mean?
Parsing the implications:
I’ve seen a lot of headlines saying these moves are anticipating a trade deal. This implies traders are trying to front-run a strengthening of these Asian currencies. Given the magnitude of the move this seems unlikely. The speed and scale of these moves is more likely a result of forced trades - covering losses or hedging against further loss by insurers.
For US Policy/Trade: A stronger TWD (meaning a weaker USD vs TWD) automatically makes Taiwan's exports more expensive and US imports cheaper. All else being equal, this mechanically reduces the US trade deficit measured in USD. Whether intentional or not, this aligns with stated goals of reducing trade deficits, potentially giving negotiators leverage even if it hurts Taiwanese exporters. It also fits a broader narrative some attribute to the Trump administration – wanting a generally weaker dollar to aid competitiveness.
For China: A stronger TWD can exert upward pressure on the neighbouring Chinese Yuan (RMB). Given China's current weak domestic economy and desire to stimulate without triggering capital flight from a weakening currency, a slightly stronger, stable RMB might be desirable. It potentially gives the People's Bank of China (PBOC) more room to ease domestic liquidity conditions.
For Asian Exporters: They face a dilemma. Allowing currencies to strengthen appeases the US on trade and helps combat imported inflation, but hammers their export competitiveness and therefore economy. Resisting the appreciation requires intervention.
The Choices Ahead & Global Liquidity
This leads to the crucial question: what do Asian central banks (especially Taiwan's) do next? Broadly, there seem to be three paths:
Allow Strengthening: Let the TWD (and potentially other regional currencies) continue to appreciate against the USD. This helps the US trade narrative and likely the US economy and markets but hurts local exporters and economic growth.
Intervene via FX: Fight the appreciation by actively selling TWD (effectively printing it) and buying USD/US Treasuries. This stabilizes the currency but means accumulating more potentially depreciating USD assets and, crucially, injects TWD liquidity locally and potentially contributes to global USD liquidity (as reserves are bought). This is likely if Scenario 1 becomes too painful economically. It seems somewhat counterintuitive, but the weakness in the USD may increase the demand for USD/US Treasuries.
Domestic QE/Stimulus: If their economies slow too much due to strong currencies or global factors, they might resort to domestic Quantitative Easing or other stimulus, further adding to local and potentially global liquidity.
The Bottom Line (For My Framework)
All three of the above scenarios appear to be somewhat bullish for US markets. In Scenario 1 we see a likely favourable resolution to the trade war and lower tariffs all-round. This is likely to be perceived well in the US. Scenarios 2 and 3 are distinctly bullish from a global liquidity perspective. Why? Because intervention to weaken a local currency (Scenario 2) involves creating more of that currency to buy foreign assets (mostly USD/Treasuries). Domestic QE (Scenario 3) is direct money creation. Both paths lead to an increase in overall liquidity sloshing around the global system. Both of these feed into argument for owning bitcoin I discussed here.
So, while the sharp move in the TWD might seem like a niche FX story, I see it as a potentially important signal. It reflects fundamental trade imbalances, a structural issue with Taiwanese life insurers and highlights the pressures caused by volatile US policy and potential shifts in USD/Treasury appeal. And most importantly, it could force actions by Asian central banks that ultimately increase global liquidity and kick off the next leg of global M2 expansion.
As regular readers know, in our post-2008 world, more liquidity tends to find its way into scarce assets and risk markets. Watching the TWD might just be giving us a sneak peek at the next chapter.