It isn't QE2 that's flooding Asia with Hot Money

See also: East Asia's Exchange-Rate Disparities

One piece of received wisdom, accepted also in the ADB report, is that developing Asia has been the none-too-welcome recipient of a flood of money created by US quantitative easing and similar policies in other developed countries. This is said to have pushed up their currencies and asset prices, justifying restrictions on capital inflows through new regulations and tax measures.

But the data actually given by the ADB suggest that the main cause of upward pressure has been the rise in the current account surpluses of these countries. The only one where such inflows have been very significant is China, which has resisted significant currency appreciation and kept its interest rates at levels which make no sense for an economy growing at 9 percent and experiencing 3-4 percent inflation.

Taking the four main Asean countries together (Indonesia, Malaysia, Thailand and the Philippines) the ADB data shows that in the first half of 2010 surpluses on the aggregated capital accounts amounted to just 1.2 percent of GDP while current account surpluses were 4.3 percent. “Errors and omissions” showed an outflow of a massive 2.3 percent.

The small net capital inflow was in contrast to 2009 when there was net outflow amounting to 4.5 percent of GDP following a similar outflow for 2008 – which saw inflow in the first half of the year then massive outflow as the global crisis hit.

Looking at the individual countries within this group, it is clear that the two with the lowest current account surpluses, Thailand and Indonesia, have also been the least concerned to prevent their currencies rising more than others in the region. Although they have imposed some controls, they are still more easily accessed than the Malaysian ringgit which, judging by a current surplus now at 15 percent of GDP and above 10 percent for a long period, should have appreciated far more than has been the case.

The story is a little different for the Asian Newly Industrialized Countries – Korea, Taiwan, Hong Kong and Singapore – but again upward currency pressure comes mainly from current account surpluses which totaled 7.7 percent of GDP in the first half of this year while capital inflow was just 1.6 percent. The previous two years saw wild swings in the capital account as money which flooded out in 2008 flooded back in 2009 but on balance saw a small net outflow. Meanwhile current account surpluses have never fallen below 4.3 percent (in the first half of 2008) and hit 8 percent for the whole of 2009.

Korea has surely faced a surge of foreign money this year, much into a bond market offering higher returns than elsewhere as well as the prospect of currency appreciation. But the won has done no more than make up for its steep fall and capital outflow in 2008. Its current account surplus has been rising and clearly justifies a stronger won, at least against the yen.

But Korea is less of an offender than Taiwan, whose current surplus has been rising strongly and is now 8 percent of GDP, yet its currency has appreciated by a mere 5 percent against the dollar over the past year and money growth and inflation are low. Taiwan maintains by far the tightest controls of the NIEs, not a policy designed to win friends overseas.

It is only China which has seen a large net capital inflow – 3.6 percent of GDP – as well as current account surplus – 5 percent of GDP in the first half of this year following a 6 percent current account and 2.9 percent capital account for 2009 as a whole despite its capital controls and closely managed exchange rate.

China has been attempting to tighten controls to prevent this inflow from adding to already too high money growth. But resistance to significant appreciation may be having a more disruptive impact than would allowing the currency to rise another 10-15 percent.

China may be in receipt of some of those US dollars which Bernanke is endeavoring to create. But undervaluation attracts capital like nothing else so it is more than likely that China is attracting surpluses being generated elsewhere in Asia and flowing out. As for money supply growth, China's 19 percent rise in M2 this year contrasts with a US rise of a mere 3.5 percent. So who is really printing money?

For East Asia as a whole there is clearly massive scope for consumption growth in China, Taiwan and to a lesser extent Korea and equally massive scope for investment growth in the ASEAN four – preferably in productive assets not monuments like new skyscrapers in low density Kuala Lumpur.

See also: East Asia's Exchange-Rate Disparities