Asia Flirts With the Inflation Devil

Asia’s governments are forgetting some of the lessons so painfully learned during the Asian crisis and in the process they are losing an opportunity to show western nations, the United States in particular, the long-term merits of sound policies.

Instead they are deluding themselves that handouts and cheap money will be more than very temporary cures for inflation and other ills, and ensuring they continue to accumulate mountains of increasingly dodgy foreign paper assets.

This is not to suggest there is any danger of a repeat of the Asian crisis. Of countries in the region, India and Vietnam show a few – but far from all – the symptoms that could lead to a repeat of that. Most of Asia is in much better shape than the western developed world. However, responses to global events have been driven by a mix of populism and obsession with exports at the expense of balanced growth and low inflation.

Almost every country has taken refuge in the myth that inflation in energy and food prices, now flowing on to other products, is someone else’s fault. Thus, it is argued, there is no point in increasing local interest rates in response and that there is merit in helping consumers either with subsidies or reduced taxes on energy.

It is of course easy to blame a gas-guzzling US and years of US monetary excess for this. But in reality most countries have followed the US monetary lead to a greater or lesser extent, and most have followed the US lead in doing little to rein in energy consumption.

The correct response, whether of individuals or corporations, to an increase in one product price is to use less of it, thus not reducing spending on other products. That of course is easier said than done in the case of food in low income countries, but possible almost everywhere for energy and in developed and middle income countries even for food.

Look at the situation now around Asia. Korea is worried about inflation and the central Bank of Korea wants to increase interest rates. These are in fact already higher than in most of the developed world – though still barely positive in real, inflation-adjusted terms. However the fumbling government of President Lee Myung-bak is desperate to rescue his own popularity so his answer to inflation is to talk of price controls.

Avoiding sensible rate increases also finds favor with influential Korean exporters who know that a rate rise will benefit the won, which has been unnaturally weak – down 9 percent even against a crumbling dollar over the past year. Although Korea imports most of its energy, and a lot of food, and has suffered a big terms of trade shock, its current account deficit is unlikely to be more than about US$15 billion or 1.5% of GDP – a modest amount under the circumstances and compared with foreign reserves of $250 billion. The won has delivered some windfall profits to exporters at the expense of the consumer, and the inflation rate. And without interest rate rises the BoK has had to sell dollars to stop the exchange rate declining further. (Last week it spent several billion to move it from 1040 to 1,000 to the dollar, but still a far cry from the 915 of a year ago.)

China is in many ways the worst offender. Yes, it has allowed the yuan to continue to rise slowly – but it is still down on the euro, Canadian and Australian dollars, and on a par with the yen. But much of China’s inflationary binge can be blamed on years of US-linked easy money and negative real interest rates.

Compounding the problem has been massive subsidies to the energy consumption that China says it wants to curtail. Although some have been reduced, power price controls have now pushed some big companies into losses. The idiocy of China’s policies should have come home to China’s rulers in recent days. It is the world’s largest holder of the paper of the world’s largest creditors – Fannie Mae and Freddie Mac, whose debts are bigger than those of the US Federal government.

Of course, Fannie and Freddie will not directly default. But what price US Treasury paper now that it stands behind these two bloated monsters? Yet given current policies in China, the nation has no alternative but to keep accumulating US debt at a rate of US$1-2 billion a day, all in the name of enabling exports to remain hyper-competitive. Acquiring assets certain to decline in price is as idiotic as some of the frenetic foreign borrowing that preceded the Asian crisis. It is simply the other side of the same coin.

Then there is Hong Kong, the one economy that did not even pay lip service to a lesson of the Asian crisis – the danger of an exchange rate tied rigidly to another country. It could have used China’s yuan flexibility, or the weakness of the US dollar against almost all currencies, as a reason to end the 25-year-=old peg. But, typically for a government which seldom makes any decisions unless prodded by Beijing, nothing was done so it has had to face the inflationary consequences not just of world prices and a weak dollar but China’s mix of inflation and yuan appreciation.

Popular sentiment against a government of oligarchs and highly-paid bureaucrats was rising so in the wake of a visit by China’s vice-president Xi Jinping the government announced a rag-bag of measures including power and transport subsidies and public housing rent holidays to soften the inflationary blow and help pro-government candidates in September elections. But they make scant economic sense and most are temporary or one-off handouts.

In Thailand there is clearly a struggle for influence between the unsteady government of Samak Sundaravej and the pro-Thaksin camp and the Bank of Thailand. The day after Samak announced measures to stimulate the economy and offset price increases, the Bank raised interest rates a notch. Samak’s $1.4 billion stimulus is the usual populist (and economically counter-productive) package – cuts in fuel duties and subsidies for power and transport.

The BoT was already behind the curve and had kept rates steady for far too long despite inflation and a weakening currency – down 10% against the dollar compared with a year ago. Given its own position as a major food exporter, Thailand’s terms of trade have not suffered from its need to import oil. Inflation changes internal terms of trade too, to the disadvantage of Bangkok. But with GDP growth still over 5% and the current account roughly in balance even with oil at $140 Thailand has scant excuse for a weak currency and negative real interest rates other than messy politics.

These are just some of the more conspicuous examples of policy failures which weaken Asia’s claims of economic leadership. There are plenty of others. They fail to contain inflation, distort domestic demand and subsidize the bail-out of Wall Street.