forex dynamics

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The International Herald Tribune | www.iht.com

Philip Bowring: An obstacle to global recovery
Philip Bowring IHT
Monday, July 28, 2003

Asian currencies

HONG KONG Asian currencies are on the move from the business pages to the
front page. Just as the overvaluation of Asian currencies in the mid
1990's helped create conditions for the Asian financial crisis, so
undervaluation now is an obstacle to restoration of global financial
equilibrium.

It will need tough political decisions as well as clear economic
assessments to bring about change. Before that, expect sharpening
exchanges of words. Among others, the U.S. Senate is now on the case.

Expansionary U.S. policies and a strong dollar helped the wider world
escape from Asian crisis contagion from 1997 to 1999. Now it is Asia's
turn to help offset the disequilibrium evidenced by the U.S. trade
deficits. But there is scant sign that an East Asia so long obsessed with
exports, and so reliant on the United States as the engine of global
growth, will recognize its international role.

Although several Asian countries have floating exchange rates, these are
managed to maintain a close relationship with the dollar, thereby
sustaining huge trade surpluses and gains in foreign currency reserves.
Asians boast of the size of their reserves, yet fail to see the
longer-term dangers of funding U.S. credit excesses. When the day of
reckoning arrives, they will lose a lot more than Western and Japanese
banks did from funding the Asian credit excesses of the 1990s.

The key to realistic exchange rates is China. No country in the region is
going to allow its currency to appreciate significantly unless China does.
Although several of the smaller economies, such as Taiwan and Malaysia,
are running proportionately larger surpluses, they are too worried about
Chinese competition to move first. Most would follow China.

Even Japan has limited reason to resist. Its exports are almost static and
it has been losing market share to China and Korea. It too is pressuring
China to revalue. But with a trade surplus of around $100 billion, its
external position is at least as healthy as that of the euro zone. Japan's
problem is weak domestic demand. It would likely cease to resist yen
appreciation if its neighbors revalued.

In response to remarks by Alan Greenspan and others, China has recently
signaled that it is willing to see a slightly more flexible exchange rate
based on a peg to a trade-weighted basket. It has been talking about doing
so for years but has never found an appropriate moment to do so. Now,
however, a gradual shift to a trade-weighted basket would be too little
too late unless also accompanied by a big revaluation.

China hates to be pushed around. But there are good self-interested
reasons for a change in currency policy now. First, monetary growth caused
by accumulation of reserves has sparked a domestic credit boom and a real
estate bubble. That needs reining in. Second, there may now be political
kudos to be gained vis-à-vis the United States and Asian neighbors by
making a virtue out of necessity, just as China did in 1997. Then it won
praise for not devaluing during the Asian crisis; it did not need to,
having devalued three years earlier.

China's trade competitiveness is such that it could easily stand a
25-percent revaluation against the dollar. South Korea, Taiwan, Malaysia
and Thailand could bear appreciation of at least 20 percent. Exports would
suffer a little, but what all East Asian countries have to accept is that
the U.S. consumption excesses they are financing and feeding cannot
continue.

Currency changes alone will not bring the U.S. deficit down to sustainable
levels. But they would be a step toward needed adjustment by East Asian
economies which have yet to recognize how vulnerable their U.S. market
must now be to disruption, whether caused by a dollar debacle, a return to
recession or U.S. protectionism.

Asia's future must lie primarily in domestic demand and exports to
non-Western destinations. Revaluations would stimulate domestic demand and
regional trade. Asians should be asking themselves whether they need more
assets in a country whose level of debts to foreigners casts doubt on its
ability to repay them. The more than $1 trillion in U.S. debt that East
Asian economies now possess may well prove one of the worst investments
ever made. Why throw good money after bad by acquiring more such low
yielding bonds in an oversupplied currency?

China should be bold and take the lead. A big yuan revaluation now would
spike the protectionists' guns, ease trade tensions and improve national,
regional and global financial equilibrium.