Asia/Pacific: Asia Can Defend Itself
Andy Xie (Hong Kong)
Asia is at a crossroads. If the region remains passive in its exchange rate policies, many of its economies could be trapped in deflation, low growth, and strong currencies for years to come, in my view.
The rapid ascent of the Korean won could not have come at a worse time. Korea’s domestic demand is stagnant. The high household debt remains a strong headwind against any consumption recovery. The small and medium enterprise (SME) sector is also weighed down by a heavy debt burden and soft sales, which limits any capital spending recovery. Korea’s exports are decelerating due to a weak DRAM price and China’s import slowdown. If the won continues to appreciate, as many market participants expect, Korea will see a recession next year, in my view.
The US economy is accelerating again and growing at about 4.5%. Europe and Japan are practically stagnant. The middle-income economies like Korea’s are growing slowly, if at all. Most emerging economies are also decelerating. The global economic cycle is decelerating despite a stronger US economy. The US is the strongest large economy in the world now, but it wants to push down the dollar.
Many in the US argue that it should devalue to decrease its current account deficit. I doubt that it would be effective. Currency adjustment works for a small economy relative to the world. The US is one-fourth of the global economy. It is difficult to imagine that changing the dollar value alone would eliminate its US$600 billion current account deficit. Hence, as the US merrily pushes down the dollar, the world could be headed for a financial crisis.
The US encouraged overconsumption through tax cuts and super low interest rates to avoid a recession after the tech bubble burst. This is the primary reason why the US current account deficit is so big. Of course, the rest of the world is also responsible. As Americans continued to binge, everyone else was happy to sell into the booming US demand and even fund the US binge with their surplus dollars.
The right solution to the US deficit, in my view, should primarily be in the form of higher US interest rates and taxes to discourage consumption and boost savings in America. But all informed people in the US would say that this is not possible: Americans would not accept a downturn, and, hence, the US government should push down the dollar to solve the problem.
Would a weak dollar solve the US deficit problem? It works in theory by making imports more expensive to Americans, which encourages production for import substitution, and exports cheaper to foreigners, which boosts production for exports. However, the US needs to build factories to realize such benefits from a cheaper dollar. With a low savings rate, it would need to borrow more from other countries to build such factories, which would increase the US current account deficit in the short term.
The danger for Asia is that it could push the region into the trap of deflation, low growth, and strong currencies. Asian economies are heavy in manufacturing. Strong currencies would cause de-industrialization, which boosts capital surpluses and makes strong currencies even stronger.
The world has been in an unstable equilibrium with the US borrowing and consuming, and Asia producing and lending. As the global economy slips out of this unstable equilibrium into something else, the future has multiple equilibria. If Asia remains passive when the US is pushing, it could be trapped into an equilibrium in which Asian economies would be characterized by low growth, deflation, and current account surpluses to fund the re-industrialization of the US.
Asian countries could take a few steps to safeguard their interests and prevent the US from dictating an outcome for the region:
First, Asian countries should shorten the duration of their dollar reserves. Asian central banks have been purchasing US treasuries when they buy dollars from hot money or trade surpluses. This action has artificially kept the US bond yield low, which has boosted the US housing market and consumption through mortgage refinancing. If Asian central banks keep their dollar reverses in the money market, the dollars would go back to the Fed, as it targets short-term interest rates. Hence, the interventions by Asian central banks to neutralize the hot money would be neutral to the US money supply.
As the Asian central banks sell US treasuries, the result would be to boost the US bond yield and decrease US consumption. The rising bond yield would force the Fed to raise interest rates more and quicker, as it should in light of the excessively accommodative monetary environment relative to the US economic growth rate. These two effects from Asia’s selling treasuries could stabilize the currency market.
Second, Asian central banks should prepare for and, if need be, implement monetization of government debt. This willingness to dilute the currency value is a powerful weapon to dissuade the hot money from pushing up Asian currencies.
Hot money can profit from pushing up Asian currencies under two conditions. First, Asian banks intervene in the market, which allows the hot money to build up massive positions. Second, when the central banks retreat, the hot money can push up the currencies quickly to cause panic among Asian businesses. When Asian businesses buy Asian currencies aggressively out of fear for their survival in the global market under constantly appreciating currencies, this is the moment that the hot money players could sell their holdings at sizable profits.
If Asian central banks show their willingness to dilute the value of their currencies, they would send a powerful signal to their domestic businesses that they should not panic despite the recent appreciation in their currencies. When the probability of such panic is low, the hot money is likely to leave.
Third, Asian economies should organize to negotiate with the US collectively on how to correct the global imbalance. Korea is in a unique position to coordinate such an effort. The US should increase interest rates and taxes to decrease the imbalance, while Asia should change its habit of always promoting investment and exports. When Asia sits down with the US collectively, it needs to propose policy changes that would boost Asian consumption, in my view.
Changing the region’s policy of high property prices is the key to correcting its bias towards savings and investment, in my view. A developing country needs to invest to develop. It requires high savings rates. Keeping property prices artificially high is the most effective means of increasing the savings rate, as it increases the propensity to save among working people in order to keep a roof over their heads. Japan, the Asian Tiger economies, and now China have all gone down that path.
Japan and the four Tiger economies have already passed the phase of rapid capital accumulation. They should decrease the ratio of property prices to income and make it closer to that in the US or Europe, which would increase consumption preferences closer to levels in the US or Europe. The irony is that bringing down property prices relative to income is bad for consumption in the short term. But, without this fundamental change, Asian consumption will always be elusive, in my view; when people have to pay so much for property, they tend to consume less.
Asian cooperation depends on Japan’s willingness to work with other Asian economies to confront the US. Most market observers would find such a proposition laughable. Japan has shown its willingness to comply with every US wish in the past few years. Asian economies have registered low in Japan’s policy considerations. However, yen appreciation may well push Japan back into deflation. Shouldn’t Japan be scared of such a prospect?
Many in the market argue that the yen could appreciate more because deflation has made it cheaper against the dollar in real terms. However, deflation happened in Japan for a reason. It was a form of adjustment. Using deflation to justify a stronger yen is to deny the need for an adjustment in Japan in the past. In my view, significant yen appreciation would almost certainly push Japan back into deflation.
It is in the overwhelming interest of the region to stand its ground. The only sustainable economic equilibrium is a cooperative one, in my view. I believe the world needs to dissuade the US from using hot money to push the global economy in its direction only. |
