Tumultuous Week for Asia's Currencies
The herd mentality of traders in the currency markets was yet again on display this past week as the US dollar soared and stock markets collapsed in the wake of the gloomy outlook painted by the US Federal Reserve. The players in these markets appear to have minimal knowledge of the actual conditions prevailing or knowing the difference between for example Korea and Indonesia. It is no wonder that supposed experts like UBS lose billions through ineptitude when they entrust clients’ money to kids almost straight out of college.
The only Asian currencies which did not suffer from last week’s panic fit were the Japanese yen, which despite everything actually happening in that country has assumed “safe haven” status in the mind of the market, along with the US-dollar pegged Hong Kong dollar and the Chinese yuan, in which there is no free market.
Perhaps the most remarkable non-sequitur was the collapse of the Korean won from around 1050 to the dollar in August to 1150 last week. Thus within a few weeks of Korea making strenuous efforts to limit capital inflow and keep its currency weak, particularly against the yen, it was having to scramble to defend it. The simpletons in the market made two assumptions. First that Korea was endangered by the size of its private short-term foreign debt and secondly that as an exporting powerhouse it was vulnerable to a global slowdown, and a China slowdown in particular.
Surely the Korean private sector tends to over-borrow but the Bank of Korea’s US$300 billion in reserves are more than enough to shield, if needed, its system from any sudden withdrawal of foreign credit. For sure too, global problems will hurt Korean exports but Korea’s competitiveness in international markets is very clear as its large current account surplus – 3 percent of GDP -- suggests. Its terms of trade could well be improved by the sharp decline in commodity prices which will cut both its import bill and an inflation rate which has been running at 5 percent.
Korea also enjoys a strong fiscal position so that those wishing to flee countries with excessive public debt and deficits – i.e. almost all the old developed countries – should view Korea as a safe haven.
Much the same argument applies to Taiwan. Its currency has fallen less steeply -- from an August high of 28.5 to the US dollar to 30.5 – but that has been due more to the tighter controls which its central bank exercises. Taiwan is supposedly more vulnerable to China but in practice its main markets are global and China is primarily an assembly point for its electronic products.
An even bigger fall from grace last week was the Singapore currency, often viewed as an Asian bellwether albeit one carefully managed by the Singapore Monetary Authority. For sure, in some respects Singapore can be seen as a “warrant on the world” and its previous strength may have been starting to worry some of its exporting and tourism sectors. But the crash from a peak of S$1.20:US$1 in August to 1.31 at one point last week was a shock which owed little to fundamentals – even if Singapore’s additional losses on its UBS investment further soured the mood. No one suggests that Singapore has fiscal or debt problems and yet its bonds yield more than US Treasuries and German bunds.
But one currency which deserved to take a hit surely did so – the Australian dollar. As Asia Sentinel has repeatedly observed the Aussie dollar had been driven to ridiculous levels by a combination of blind market faith in commodities and relatively high interest rates attracting the savings of Japan’s “Mrs Watanabes.” Foreign mania for the Aussie long continued blind to the fact that despite almost unprecedented gains in its terms of trade Australia was still running a large current account deficit. Worse still, though government debt is small, household debt levels are horrendous thanks to years of escalating house prices and easy access to mortgages. One day the markets may wake up to the double vulnerability of Australian banks -- as big net borrowers on international markets and as lenders to a property sector which could well crash.
Commodity markets are just beginning to recognize that their problems lie not only with likely fall in the rate of growth of demand in China but with the fact that new supply is just beginning to come on stream. Each commodity has a different profile. Copper remains scarce while iron or is suddenly abundant. But do not imagine that the 11 percent fall in the A$ since its August peak, or the 5 percent decline last week, is the end. The commodity cycle, which more than doubled the value of the A$ from a nadir of 48 US cents in 2000 – with a brief dip to 65 cents in late 2008 -- has finally turned. The downhill slide will be long.
Another commodity currency is the Indonesian rupiah which likewise has suddenly fallen out of favor and was down almost 10 percent from August to 9,500 to the dollar before recovering to 8,770 on central bank intervention. The country’s main commodities, coal, gas and palm oil, are still in relatively good shape but energy values are looking vulnerable and there are coal projects galore around the world which sooner or later will make life much more difficult for Indonesia.
Although there is no doubt potential for Indonesia to continue to grow steadily on the back of consumer demand, that needs to be underpinned by export earnings by farmers as well as corporations. A significant terms-of- trade decline would quickly eliminate the country’s current account surplus and curtail investment spending. For sure, Indonesia has a conservative fiscal regime and limited capacity to over-spend on projects. Nonetheless, it has been basking in foreign approval for too long and may need some external shocks to shake the complacency of a government which owes its current appearance of steady growth more to chance than to its own efforts.
The Malaysian ringgit is also mostly viewed as a commodity currency and so its recent fall from 2.995 to 3.165 to the dollar was little surprise. However it is clearly not as vulnerable as other commodity currencies. The ringgit has long been viewed as seriously undervalued, at least as indicated by year of current account surplus ranging from a high 8 percent of GDP to a monstrous 15 percent. Like the Thai and Taiwan currencies it had been edging back towards its level against the US dollar prior to the 1997 Asian crisis. In theory a stronger currency would help boost domestic demand and hence also, perhaps, long lagging private investment. However, it is also possible that a large current account surplus is a necessity to finance the capital outflow endemic to Malaysia which is partly at least a direct result of its ethnic policies. A sustained fiscal deficit is a long term worry but helps offset the weakness of private investment.
Perhaps surprisingly, the Thai currency has been among the more stable of the Asian floating currencies, the baht falling only 6 percent from its August high of Bt29.8:US$1 to 30.9. This was despite concerns that the new government of Yingluck Shinawatra was embarking on a series of populist wage and subsidy policies which would reduce competitiveness and raise government debt levels. How much of the stability was due to central bank action is not clear. However, the market may sense that its agricultural commodities are as vulnerable as minerals to the turn in the commodity cycle and that its tourism and manufactured export strengths give it greater diversity than most countries in the region.
Panics elsewhere also help explain why the Vietnamese dong, so long a candidate for constant devaluation, has been looking unusually healthy. Then collapse in the price of gold, a significant element in the local financial system, has actually helped the dong, which was already looking steadier as tight credit is reducing the current account deficit and should see inflation, which peaked at 20 percent, back in single digits in 2012.
Taking East Asia as a whole, there are certainly good reasons to believe that the next 12 months or more will be difficult thanks to stagnation in the west, debt levels in China, gyrations in commodity prices and currencies. It is also clear that some developing countries are putting up barriers to Asian competition. Despite its BRIC rhetoric, Brazil has just raised tariffs on many manufactures in a move clearly aimed mainly at China.
Nonetheless it is hard to believe that most Asian currencies – the yen excepted – remain significantly undervalued against western ones. In almost all cases their fiscal and debt situations are favorable and they are able to sustain higher interest rates both now and in the foreseeable future. In short, there is every reason for money to stay in Asia but for investors to become much more selective than was the case last week.