Editorial»
The limits of currency rhetoric
JAN 06 - If China does finally allow the yuan to rise against the dollar this year, and if other Asian countries seem less inclined to beat down their currencies, don’t rush to congratulate the US treasury secretary, John Snow. Throughout 2003, Snow led the chorus exhorting Asian governments to stop meddling in the currency markets. He failed to make a dent. The yuan remained pegged to a falling US currency as the central bank in Beijing mopped up the dollars that investors and exporters kept pouring into the country. The Chinese weren’t alone in the game. Every major Asian central bank sold its currency to protect export competitiveness, even as US manufacturers and politicians relentlessly cried foul. The Japanese yen, the South Korean won and all other Asian currencies have risen no more than 11 percent against the dollar, compared with a 19 percent gain for the euro, and a 30 percent rise in the South African rand in 2003.
When it comes to currencies, Asia, it seems, has scant regard for free-market morality.
In February, Snow will again demand an end to currency manipulation at a meeting of the Group of 7 industrialized nations. Chances are, he will get another tepidly worded communiqué, extolling the ideal of flexible exchange rates. If he is looking for a pledge from Japan that its central bank will stop selling the yen, he will fail once again. It is useful to shut out the noise about whether Asian central banks should or shouldn’t sell their undervalued currencies and consider the real question, which is whether Asian governments will be able to keep their currencies from rising amid accelerating global growth.
Analysts at Goldman Sachs Group are predicting that Asian governments may let their currencies rise against the dollar by the second half of this year. Why? To answer that question, Goldman Sachs economists Sun-Bae Kim, Adam Le Mesurier and Enoch Fung suggest we look at the single-biggest enabler of low exchange rates in Asia: a weak market for bank credit. For example, in Thailand, outstanding bank loans amounted to 5 trillion baht, or $126 billion, in September - 21 percent less than in June 1998. In fact, since the financial crisis of 1997, Asian companies have been ridding themselves of debt by shedding excess capacity.
As a result, fixed asset investment in Asia is pretty much where it was before the 1997 financial crisis. In South Korea, real gross capital formation, a measure of investments in the economy, was 5 percent lower in the first nine months of 2003, compared with the same period in 1996. How did this unraveling of capacity allow Asian central banks to keep exchange rates low? For that, let’s examine the biggest argument against a central bank selling its currency. As it mops up from commercial banks an ever-rising amount of dollars being deposited there by exporters and investors, the central bank leaves more and more of the local currency in the banking system. That easy money creates an inflationary bubble.
If companies are shedding capacity, and as a consequence, new jobs aren’t being created, there is little demand for bank loans, either from businesses or from individuals. In other words, there is no threat of a bubble. Commercial banks are glad to park their money back in government securities. All that will change in 2004, Goldman Sachs predicts. As the global recovery gets stronger, companies in Asia will become more confident about making new investments. Demand for industrial credit will pick up. Commercial banks will want to do more than just park their money in government securities.
Inflation will make a comeback, and “pressure will build,” the Goldman Sachs economists say, “to accommodate real exchange rate appreciation through appreciation against the US dollar.” If any Asian central bank still keeps buying dollars, it will be leaving too much easy money on the table, exaggerating inflation trends in its economy, and running the risk of stamping out growth. Alan Greenspan, the chairman of the US Federal Reserve, recently indicated how that could be a threat for China, which incidentally is the only Asian country to have added a significant amount of industrial capacity in the past six years. Continued buying of dollars by the central bank in Beijing “threatens an excess of so-called high-powered money expansion and consequent overheating of the Chinese economy,” he said.
Seven of 11 currency strategists recently polled by Bloomberg News said that they expected China to revalue the yuan by the end of 2004. Thus economics, and not any amount of sermonizing by Snow, will steer Asian central banks away from buying dollars. That could mean less investment in US Treasuries by Japan and China, the world’s two biggest holders of long-term US government debt. Who will then provide the $1.5 billion a day the United States needs from the rest of the world to finance its current-account deficit? In a year of US presidential elections, that would be the real downside to Snow’s free-market morality on exchange rates. Posted on: 2004-01-06 02:40
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