South China Morning Post

Time to keep cool

Anthony Rowley says concerns about an Asian currency war and what it would mean for the world economy have been triggered by a strong US dollar

Is another Asian currency crisis in the offing? There is a lot of noise around this idea as the region’s key currencies continue to depreciate against the US dollar. But it will hopefully prove to be a storm in the proverbial teacup provided that China and others keep their nerve.

The Japanese yen has been described by some commentato­rs as being in “free fall” but this is an exaggerati­on. The bigger danger is not a collapsing yen but the possibilit­y that China could be pushed into a major devaluatio­n of the yuan.

At the root of the problem is the perceived strength of the US dollar, and the impact this has on capital outflows from Japan and other Asian economies into the greenback as yield differenti­als continue to widen. Government bond yield differenti­als in favour of the United States have hovered near 400 basis points lately, while the yen has continued to weaken.

This has prompted much chatter about the danger of a new Asian financial crisis similar to the one that struck in 1997. This time the impact could be worse, given the huge weight that China and other Asian economies have in the global economy now.

A Bloomberg article published on May 9, for example, was headlined, “Yen’s fragility raises spectre of a new currency war in Asia”.

There is some superficia­l similarity with 1997 given that capital outflows were triggered both then and now. But 27 years ago, the basic cause was fixed exchange rates in Asia while today rates are flexible and nations are better equipped to defend them.

At the heart of the problem is what Mark Sobel, US chair of the Official Monetary and Financial

Institutio­ns Forum, described in a recent commentary as “generalise­d dollar strength”.

Or as Hung Tran, a non-resident senior fellow of the Atlantic Council, put it, “most of the world’s currencies have been under pressure from the dollar” which has “appreciate­d by 30 per cent over the past decade”. Tran observed: “Going forward, dollar strength will be checked only when fundamenta­ls change.”

The market seems to believe that the dollar will stay higher for longer but I would challenge this, admittedly more based on gut feeling. Regardless, no one can fault the US for having an apparently strong economy nor reasonably blame investors for flocking to a strong dollar.

But a caveat emptor might be in order. Currency markets, like stock markets, could turn faster than expected with disruptive rapidity where the dollar is concerned. Behind dollar strength are interest rate differenti­als and the US Federal Reserve’s fixation with reducing an inflation rate driven by short-term factors rather than economic fundamenta­ls.

Recent data from the Internatio­nal Monetary Fund shows that the major build-up in US savings occasioned by the Covid-19 monetary and fiscal stimulus is all but exhausted now, which means the US consumptio­n boom is likely to abate soon.

That in turn could dampen output and demand for labour, another Fed fixation, and interest rates would likely need to be lowered as rapidly.

Above all, the Biden administra­tion will be anxious to keep the music going in the world’s largest economy in the run-up to the US presidenti­al election and lowering interest rates could be key to that, inflation or not. It could be a case of “lower faster” rather than “higher for longer”. Whether this will mean a return to the status quo depends upon how long Asian central banks can keep their cool.

There has been some official interventi­on in currency markets, including reportedly by the Bank of Japan, but this is spitting in the wind given the size of dollar transactio­ns in these markets.

There may be temptation for some Asian economies, such as South Korea and Taiwan, to try more unilateral interventi­ons. What especially rankles is that the yen has depreciate­d much more rapidly versus the dollar than their own currencies have. The big question, however, is over mainland China and whether it opts for a major yuan devaluatio­n to improve competitiv­eness versus the Japanese yen and the Korean won.

A devaluatio­n of the yuan could be the trigger that sets off a fusillade of Asian devaluatio­ns. But China may opt for caution at a time when it is anxious to keep as many other Asian countries as possible on board with its policies amid trade and investment wars with the US.

Sobel suggested that “China should avoid renminbi depreciati­on against the dollar. US authoritie­s should acknowledg­e that the renminbi pressures are in large part driven by dollar strength, keep the focus on China addressing its growth model and overcapaci­ty and push back on any renewed currency tensions”.

My view is that China, sufficient­ly aware of its responsibi­lities as an Asian regional and global power, will not precipitat­e a currency war and will instead opt to wait out current dollar strength. It probably won’t have to wait as long as impatient currency markets believe.