Splendid article by Anatole Kaletsky in Tuesday's Times...
Europe and US must beware of the five tigers
WITH the general election and then the French referendum, the focus of market and media attention in the next two months will be firmly on Britain and Europe, but the events that really matter for the world economy will be happening mainly in the Far East. Later this week, while businessmen and policymakers in Britain will understandably focus on the parochial issues dominating our election, such as public spending and taxes, the IMF and the Group of Seven Finance Ministers meeting in Washington, will have the much more important question of Asia on their minds.
Asia’s trading, financial and currency relationships with the US and Europe have become item one on the agenda of G7 finance ministers and central bankers. Asia has been largely responsible for the strength of global growth in the past two years, but also for the surge in oil prices and for the unprecedented magnitude of global trade imbalances. Asia holds the key to the currency conundrum that dominates every meeting: how to achieve an orderly adjustment of the dollar to narrow the US trade deficit, without inflicting a disastrous recession on Europe through an even more overvalued euro. The only way to do this is to engineer a revaluation of the Asian currencies against the dollar and the euro (and, of course, against sterling as well).
This issue is becoming more urgent by the day. The US trade deficit is now running at $700 billion (£370 million) a year, with little or no improvement in sight at least in the short term. Indeed, according to Ian Shepherdson, of High Frequency Economics, the trade-weighted dollar will have to decline by a further 3 per cent a year, just to keep the deficit unchanged. But the eurozone is on the brink of another recession and possible political upheaval, largely as a consequence of the damage done by the overvalued euro not only to exports, but more importantly, to investment and jobs. Any further depreciation of the dollar against the euro would be catastrophic, not only in economic, but also in political, terms.
Moreover, a devaluation of the dollar against the euro would not diminish the global trade imbalances but merely redistribute them in an even more unstable way. Instead of America having a $700 billion deficit, while European trade is more or less in balance, a further decline of the dollar against the euro might reduce the US deficit to just $350 billion, but only at the expense of an unprecedented $350 billion deficit in the eurozone. For Europe, and in particular for Germany, whose growth has been almost entirely dependent on exports, a move into trade deficit would represent a devastating blow. Meanwhile, the vast trade surpluses built up in the past few years by the Asian countries would remain unchanged — and might even increase if the euro continued to rise against the Asian currencies as well the dollar.
The solution to this impasse has long been obvious. The dollar and the euro should depreciate against Asian currencies. But how is this to be achieved? At present all Asian governments, with the partial exception of Japan, either peg their currencies officially to the dollar (as in China and Hong Kong) or spend tens of billions of dollars to intervene in the foreign exchanges. This currency intervention is openly justified by Asian politicians as a means of protecting competitiveness and promoting exports. This Asian currency mercantilism represents an export subsidy and trade distortion far bigger than the steel, textile and aircraft disputes, on which the US and European trade ministers waste most of their time.
Why, then, has nothing been done to force the Asians to abandon their currency manipulation? The answer is surprisingly simple. Markets and G7 policymakers have focused on the only two Asian countries that seemed to matter — Japan and China. But on closer inspection, neither Japan nor China, turned out to be appropriate targets.
Japan has not intervened in its currency markets for more than a year. And when Tokyo was artificially holding down the yen, it had a reasonable justification — a cheap yen was need to help to pull the world's second-largest economy out of a 12-year recession, which was doing the global trading system even more harm than the undervalued yen. Now that the Japanese economy is recovering, it could certainly cope with a gradual strengthening of the yen. But Japan’s relatively high labour costs relative to Asian countries such as Korea, Taiwan and Singapore, which are now at a comparable technological level, make the Japanese nervous about being undercut by cheap-currency competitors.
China, meanwhile, has been selling renminbi (RMB) and buying dollars not so much to keep its exports competitive, but to maintain some semblance of stability in its domestic banking system. Moreover, while China has a large surplus with the US and Europe, its overall global trade is not far from balance, because of the enormous deficits it runs against Japan, Korea and Taiwan. On closer inspection, it turns out that much of the value of the goods shipped by China to the US and Europe actually originates in Japan, Korea and Taiwan. Finally, China's wages are so low that even a huge RMB revaluation would be no help to labour-intensive industries in the US and Europe, which China would continue to undercut. The beneficiaries of an RMB revaluation would be factories in Vietnam, Indonesia and the Philippines, not in South Carolina or Spain.
For these reasons, the Chinese and Japanese would almost certainly be willing to participate in a currency revaluation which extended across the whole of Asia but they see no reason why they should take the lead. But if Japan and China will not lead, who can? Two months ago, I suggested a possible answer on this page. The smaller Asian economies, specifically the five newly industrialised “Tiger economies”: Korea, Taiwan, Singapore, Malaysia and Thailand. These are the countries with the world’s biggest trade surpluses relative to GDP. Their industrial structures are now directly competitive with Western countries. Although living standards in Taiwan, Korea and Singapore are comparable to those in the US and Europe, wages are 50 to 70 per cent below Western levels.
Moreover, these countries have been accumulating reserves much faster than either China or Japan. Korea foreign exchange reserves at the end of March stood at $205 billion, and Taiwan's at $247 billion, compared with Japan’s $841 billion and China’s $610 billion. Since the Korean and Taiwanese economies are about one-eighth the size of Japan and China, their reserve accumulation has been far more aggressive — and potentially disruptive to global trading. This is even more true of Malaysia and Singapore.
So far, neither investors nor Western policymakers have paid much attention to these smaller Asian currencies. Most investors have considered buying these currencies to be too risky. Meanwhile, G7 policymakers have paid no attention to the Asian tiger currencies on the grounds that these economies were insignificant in the broad picture of global trade.
But as it becomes increasingly clear that neither China nor Japan is going to lead an Asian revaluation, the G7 finance ministers’ attention could shift to the smaller Asian currencies. If it did, they would notice not only that Korea, Taiwan, Malaysia, Thailand and Singapore are the countries most involved in currency manipulation, but also that these currencies really matter in world trade.
As shown in the bottom chart (based on the useful league tables in the Competitiveness Report produced by the Institute for Management Development in Lausanne) the combined exports of these five countries (excluding re-exports from Singapore) amounted to $750 billion last year. That was 25 per cent more than the $590 billion exports from China, before we consider that a high proportion of China’ s exports are final assemblies of high-value components made in Korea or Taiwan.
The markets also seem to be waking up. According to Bloomberg, the world’s strongest currency in the first quarter was the Korean won. The won has appreciated 2.5 per cent against the dollar and by 6.5 per cent against the yen since the beginning of the year. In the past two weeks it seems to have broken out of the eight-year trading range in which it has been confined since the Asian crisis. If markets can push the Korean won out of its post-1998 trading range, Taiwan, Singapore and Malaysia will surely be forced to follow. This could be the start of an Asian crisis in reverse — and a huge relief to the world economy as a whole. |
