Asia's Currency Market Shakeup

There has been plenty of recent action on Asian currency markets. But regrettably none of its points in the direction of the greater currency coordination the region's finance ministers and central bankers claim they want.

Most spectacular was Japan's sudden intervention last week, the first such since 2004, to suppress the value of the yen, driving it back to 85 to the dollar after it hit 82 and threatened to breach the all-time high of 80 reached in 1995.

This intervention upset the US and Europe, which feared it would be an excuse for China to continue to manipulate the yuan and prevent it rising as market forces suggest it should. But naturally Japan, mired in deflation, is reluctant to carry so much of the burden of international currency adjustment while China refuses to budge.

China likes to argue that a rapid rise in the yuan would not only do little for the trade imbalance but would threaten it with a repeat of the Japanese situation after the 1985 Plaza accord which resulted in a sharp revaluation against the dollar. China sometimes argues that the Japanese credit bubble was a direct result of monetary stimulus to offset the negative impact of currency rise on exports. But this seems disingenuous. China already has a credit bubble partly caused by the massive rise in its foreign exchange reserves resulting from actual and perceived currency undervaluation.

But China is not totally alone in the manipulation business. Korea and Taiwan, neither of which has fully open capital markets, undertake their own interventions to give themselves a trade advantage against Japan.

The numbers are especially stark in the case of Korea. Before the 2008 global crisis the yen was buying eight Korean won. Now it buys 13 won. Meanwhile reserves have expanded rapidly as the Bank of Korea has sought to dampen upward pressure on the won. No wonder its export growth has far outpaced Japan's. The won has also fallen against another export rival, Taiwan. Korea's manipulation has so far attracted little attention but may do so when the G20 meets in Seoul in November.

Japan meanwhile is especially upset that China appears to have been partly responsible for the rise in the Yen in recent months as it has bough Yen bonds as part of the diversification of its huge and still rising reserves. Such Chinese buying may well have also boosted the Canadian and Australian dollars, trading near their highest levels for decades against the US dollar. China's buying is understandable given the fundamental problems of the dollar and doubts about the euro in the wake of the Greek and other debt crises.

But Japan is justifiably sore that it is in no position to acquire significant amounts of yuan bonds. The onshore market is closed and the offshore one is tiny. A big story was recently made by the Financial Times about Malaysia acquiring Chinese government bonds for its reserves. But this could only have been done as a one-off agreement with the Peoples' Bank of China, possibly as part of a swap arrangement between the two central banks under the Chiang Mai initiative linking Asean with China, Japan and South Korea. Although China wants to internationalize the yuan for some purposes it still fears international market forces, and also has no need to borrow overseas – quite the opposite.

In the wake of the mountain that an increasingly nationalist Beijing has made out the recent Senkaku island molehill, it is unlikely to be listening to Japanese complaints any time soon. But it has been slightly sensitive to US pressures. In the past two weeks the yuan, which has long been stuck in a narrow range against the dollar, shot up to 6.71 from 6.80 to the dollar.

This looks more like a gesture to President Obama prior to the meeting with Wen Jiabao in New York than a major sustained change in currency policy. Indeed, at the United Nations, President Barack Obama warned Thursday that China must immediately revalue its currency, devoting most of a two-hour meeting with Chinese Prime Minister Wen Jiabao to pressing for currency reform. But it could anyway be explained away by the weakness of the dollar against other currencies, including the euro, over that period.

The Obama administration often seems more concerned with words than deeds and anyway a seriously aggressive US stance on the currency issue looks unlikely despite Obama's meeting with Wen while major US companies like Walmart and Apple derive much of their profits from cheap Chinese labor.

While China and the developed Asian economies engage in various kinds of currency manipulation, Southeast Asia's open economies have been bearing the brunt of inflows from bigger countries and the oil states, awash with cash. The Thai baht, Malaysian ringgit and Indonesian rupiah have risen by 10 percent against the US dollar over the past year and the closely managed Singapore dollar by 7 percent. Even the Philippines peso has risen 7 percent as well. Though these countries have some controls on flows, they are quite light and can be hard to enforce.

Although competitiveness has not yet been significantly damaged and current account balances remain positive, in the case of all except Singapore and remittance-dependent Philippines, that has been mainly due to the buoyancy of commodity export prices which may not be sustainable. Indeed euphoria over export recovery is already beginning to cool. Currency rates may also have begun to damage some manufacturing industries already under pressure from Chinese imports. Currency strength has done little to spur investment, though it has boosted stock and property asset values.

Whatever the governments of these countries feel about their currency values, they can see that the Asian cooperation promised in the wake of the Asian financial crisis may look good on paper but in practice provides little protection against external pressures when the larger Asian countries as well as the US and the Eurozone are engaged in their own currency struggles.