No Reason for Asia to Be Smug

From the distance of a crisis-hit Euroland or a near static United States, Asia's economies still look good. But the closer one gets to individual countries the less appealing they seem.

For a start, de-coupling from the west and hitching the wagon to China is being exposed as a half truth at best. Year-on-year trade numbers for export-oriented Asia still look good with double digit growth showing for most of them. But take a closer look and several countries are looking as though they have already reached a plateau. That is especially so for Southeast Asian countries such as Thailand, Malaysia and Indonesia. They have benefited from strong commodity prices but volume exports appear stagnant at best.

Even China is no longer quite the savior it was once assumed to be. Although real or assumed Chinese demand has clearly been the biggest factor behind the commodity boom, it does little more than compensate for western demand which bounced back from the 2009 slump but now appears sluggish.

The region's currencies have all been strong to the point of encouraging capital controls to limit currency appreciation. But much of this has been due to a combination of rising export prices and weak domestic demand resulting in large trade surpluses. It is evidence of weakness, not strength that Malaysia runs a current account surplus of 15 percent of its GDP and even the Philippines, desperately in need of capital investment, has a 3 percent surplus. Asset prices have been rising mainly as a result of these surpluses more than because of an influx of foreign money.

The negative impact of US Federal Reserve policy on smaller Asian countries is exaggerated. Over the past year money supply growth in the mid-size East and Southeast Asian countries have ranged from 4.6 percent in Taiwan to 8 percent and 9 percent in Korea, Thailand, Hong Kong, Malaysia and Singapore. Such price bubbles as have appeared have been in high-end real estate favored by Chinese buyers.

China argues that US quantitative easing is creating a wall of cheap money which is threatening to engulf other countries. But China should look in the mirror. Over the past year China's money supply has expanded by 19 percent following a rise of 30 percent in 2009. Meanwhile despite quantitative easing earlier this year, the US equivalent has managed a paltry 3.2 percent gain.

China's monetary stimulus, almost all provided by bank credit rather than through fiscal deficits, is mainly to blame not just for local real estate bubbles but for the wider inflation which is already 4 percent and could rise despite attempts to cap it artificially with price controls. A China which has kept interest rates at US recessionary levels while its economy grows at 8 percent or more could not have expected otherwise.

China demands the right to determine its own currency's value. Fair enough. But it must take the consequences if it leads to unwillingness to set interest rates at appropriate levels in order to hold its currency at levels which produce huge external surpluses. Smaller countries such as Australia, Singapore, Korea and Thailand have taken their own action on interest rates and accepted some currency appreciation to offset inflation. China has resisted this despite its high growth rate and ever-growing foreign reserves.

The danger for China now is twofold. The first is that inflation will drive up production costs and so hurt its export industries which the undervalued exchange rate was supposed to protect. The second is that belated official response to inflation will lead to overkill, with interest rates rising to levels which will both constrain consumption and expose the poor quality of so much bank lending made during the past two years of stimulus. China's massive foreign exchange holdings provide no defense against domestic lending follies reminiscent of Thailand and elsewhere in the mid 1990s prior to the Asian crisis.