Asia Under Pressure to Adjust Currencies
Wed May 14, 1:40 AM ET
By Alan Wheatley, Asian Economics Correspondent
SINGAPORE (Reuters) - Asia has a simple message to European policymakers hoping to spread the economic burden of adjusting to a weaker dollar: forget it.
Asia accounts for 40.2 percent of the U.S. Federal Reserve's broad dollar index, making a revaluation of regional currencies a key ingredient in the eyes of many economists of any global strategy to reduce the gaping U.S. current account deficit.
That reasoning looks particularly compelling to European firms that say they are shouldering too much of the burden of ironing out global imbalances. The single currency has risen some 40 percent from its lows against the dollar, eating into profits.
The problem for Europe, though, as Group of Seven finance ministers prepare to meet this weekend in Deauville, France, is that the argument cuts little ice in Asia, which remains determined to keep a lid on its currencies to boost exports.
"If the Europeans get upset with the euro, it's not obvious to me that that's going to drive Asian countries to say okay, let's sit down and talk about this," said Kenneth Courtis, Goldman Sachs's vice-chairman in Asia.
With Asia too weak to throw away the crutch of exports at a time when the SARS virus is crushing domestic demand, Jim Walker, chief economist at CLSA Emerging Markets in Hong Kong, agreed the onus of adjustment will fall more on Europe than on Asia.
"The people that are in real trouble in the global economy right now are the Europeans," he said.
CHINA LIFT
To see why, take China. Because the yuan, or renminbi, is pegged around 8.28 to the dollar, China is getting a boost from the falling dollar even though it ran a trade surplus of 1.9 percent of GDP in 2002 and has $316 billion in official reserves.
Weighing 9.05 percent in the Fed's index, the yuan should be revalued to help global adjustment, some economists conclude.
Politically, too, criticism of deliberate devaluation voiced this week by U.S. Treasury Secretary John Snow can be read as turning the heat up not only on Japan but also on China.
And if Snow wins backing for his idea of expanding the G7 to 10 or 12 countries, presumably including China, the institutional mechanism would be in place to strong-arm Asia into abandoning what many see as undervalued pegs to the dollar.
"For Asia, the implication is that the U.S. is shifting away from a long-held agnostic stance toward how other countries manage their currencies," J P Morgan analysts James Malcolm and Hui Chin Chong said in a report.
Yet many economists dismiss the idea of a yuan revaluation any time soon. In a country that prizes stability, a dearer yuan would fuel deflation -- souring more loans in a creaking banking system -- and dampen growth in job-creating export sectors.
Besides these objections, Courtis said a 10-15 percent revaluation mooted by some would have scant impact on exports for a simple reason: multinationals, many of them American, are hardly likely to shutter perhaps $600 billion to $800 billion in modern plants that form the core of their global production chains and now account for more than half of Chinese exports.
"To make a significant dent on the export side, they would basically have to put that capacity somewhere else," he said.
In fact, a revaluation could boost China's trade balance by making its imports cheaper. "It's not going to change the equation globally," Courtis concludes.
OBJECTION OVERRULED
What about the rest of Asia? One argument against capping a currency is that it distorts the allocation of resources in favor of labor-intensive export industries that eventually overheat and generate inflation. But in a world of oversupply gripped by fears of deflation, this objection is risible.
"Asia's fortune is that China is in the region. That is a powerful disinflationary force, so Asia can live with artificially weak currencies and low inflation for quite a while," said Rob Subbaraman of Lehman Brothers. "I don't think you'll get this real exchange rate adjustment any time soon."
Merrill Lynch economists calculate that Asian trade-weighted exchange rates have in fact depreciated by two percent on average since the end of January. With regional unemployment near record highs, central banks were likely to continue resisting pressure for appreciation, they wrote in a report.
"Against this backdrop, we do not expect a substantial shift in Asia's currency regimes before the end of the year."
That means Asian central banks will be adding to their $1.2 trillion in reserves. For various security-policy and financial reasons, Asia invests most of the stockpile in dollars, funding in the process about half of the U.S. current account deficit.
The result for Washington is what Courtis calls a "deficit without tears." But the corollary of the policies that generate Asia's surpluses can only be increased adjustment pressure on currencies that are allowed to float freely, notably the euro.
"The Europeans are going to find it much more difficult to live with a strong currency than a weak one," Courtis said.
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