East Asia's Exchange-Rate Disparities
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Lack of cooperation on currency matters is a serious threat to East Asia's ability to continue to lead the world in economic growth. That is the obvious implication behind the Asian Development Bank's latest Asian Economic Monitor.
The Monitor notes that although trade within the region has been growing fast at a time when US and European trade is struggling to do more than recover from 2009 declines, exchange rates between the 13-member Asean Plus (plus China, Japan and South Korea) have diverged markedly since the onset of the global financial crisis and pose threats to trade.
In theory at least, increased intra-regional trade combined with the strong external balances enjoyed by the region and its escape from the contagion which caused the crisis in the US and European banking systems should have led to increased recognition of the merits of cooperation.
In practice, however the opposite has happened as some countries have allowed their exchange rates to reflect current account surpluses and inflows of foreign capital, others have largely resisted change or introduced partial barriers to flows which have diverted the flows to other regional countries, thus widening disparities in currency performance.
Although China is not mentioned by name, it is clear the ADB's remarks are primarily aimed at its very modest appreciation at a time when most Asian currencies have risen by varying amounts against the US dollar. For example, between January and November the Thai baht rose 12.3 percent against the dollar, the Malaysian ringgit by 10.0 percent, the Singapore dollar by 8.5 percent and the Taiwan dollar by 5.1 percent, but the Chinese yuan rose by only 2.9 percent.
On an effective exchange rate basis, which allows for differences in inflation rates and trade-weights, the Chinese undervaluation was even sharper. A rise of 4 percent so far in 2010 has not yet been enough to offset a decline in 2009 which was greater than the declines of any of its neighbors other than US dollar-pegged Hong Kong and the Vietnamese dong. The predatory impact of Beijing's exchange rate policy can thus be seen to be hurting other developing countries in the region (not to mention Japan).
China's policy has clearly resulted in foreign speculation in the currencies of the likes of Thailand and Korea, which have as a result imposed some restrictions on foreign access, for example on bond purchases. It has also made it more difficult for other countries to raise interest rates to combat incipient inflation. China, with its low exchange rate and low interest rates, more than loose monetary policy in the west, appears the main source of inflationary pressures in Asia.
The question the ADB asks is how the region can tackle the exchange rate problems which are causing disruption today and could well make it much more difficult for the region to grow on the back of intra-regional trade, which will be needed to offset stagnation in traditional export markets.
In a special note the Monitor asks the question: “Exchange Rate Cooperation: Is East Asia ready?” It proceeds to examine why such cooperation is necessary and the varying levels at which it could take place. It recognizes that a European style monetary union is as yet a distant dream. But it does see merit in the kind of loose cooperation seen in Europe after the collapse in the early 1970s of the Bretton Woods system of fixed exchange rates. The Europeans attempted with a modicum of success to limit movements of currencies within the Eurozone while floating freely against the dollar. It also thinks that the East Asian group should be capable of the same sort of broad agreements that the G7 achieved in the Plaza Accord and later in the Louvre Accord to re-adjust exchange rates to prevent trade imbalances from getting out of hand and de-stabilizing the whole system.
The G7 no long rules the financial world and the G20 is simply too big and diverse to replace it. But the ADB suggests that countries within the East Asian region ought to be capable of a Plaza-style agreement among themselves. Thus even if there remains a global threat of “currency wars,” East Asia can avoid a regional one. They may even be capable of operating a system by which regional currencies were kept within a defined band vis-a-vis either each other or a dollar/euro basket
Not that the ADB gets beyond expressing hope to implying it is going to happen. In reality China is obsessed more with its relationship to the dollar and to the US generally, as well as to expanding trade outside Asia, so is unlikely to put regional relationships to the fore. And anything which requires cooperation between a China which relishes a cheap currency and Japan which cannot do much about an expensive one will always be difficult. Korea has some influence as a middling sized trading economy with a floating (but managed) exchange rate. Asean countries are too diverse to have clout as a group.
But the ADB report is a timely reminder that though East Asia remains an area of superior growth it will struggle to maintain that status in the face of weak traditional markets, declining workforce growth and the weakness of real regional cooperation.