08/12/2015
Asia / Currencies
China’s move is just a small and long-overdue adjustment that barely begins to make up for the really big moves in the US dollar, euro and Japanese yen.
China lowered its currency fixing by 1.9% against the US dollar on Tuesday. Is this an aggressive escalation in global currency wars or a desperate attempt to boost exports? Neither. A proper “devaluation” is 10-30%, and it has to stay the course for a year before exports start to show any change.
The best way to describe China’s move is as a small and long-overdue adjustment that barely begins to make up for the really big moves in the US dollar, euro and Japanese yen. Over the past year, those moves have left most Asian currencies overvalued – not undervalued – when measured, as they should be: Against a simple basket of the world’s three major currencies rather than against any single outlier like, in this case, the US dollar. Further adjustments by China and the rest of Asia seem likely and should be regarded as a good thing, not a bad thing.
Over the past year, the euro and yen have both fallen by some 19% against the US dollar. Caught in this tsunami, what have Asia’s currencies done? Just what you would have wanted them to do – swum down the middle. They have fallen against the US dollar and risen against the euro and yen. And in so doing, Asia’s currencies have maintained a modicum of stability in highly volatile waters. But closer inspection reveals that Asia’s currencies haven’t swum precisely down the middle. Most – especially the Chinese yuan and Hong Kong dollar – have appreciated along with the US dollar more than they should have. This has left them stronger, on average, not weaker. All of Asia’s currencies, save for the Malaysian ringgit and the Indonesian rupiah, have appreciated against a “tri-currency” basket by between 2% (Singapore dollar) and 14%/15% (yuan and Hong Kong dollar) since July 2014.
As Singapore knows better than most – its entire monetary policy being based on the currency rather than interest rates – stronger currencies put downward pressure on inflation and, eventually, growth. Inflation across the region has been falling for the past one to two years and most of this is due not to oil, but to stronger currencies. The arithmetic is straight forward. Most Asian countries import oil to the tune of 3-4% of GDP. A 40% drop in oil prices puts about 1.2 percentage points of GDP of downward pressure on inflation. But a currency appreciation of 10% on imports of, say, 25% of GDP, adds up to 2.5 percentage points of downward price pressure – nearly twice as much. Currencies matter.
Many of Asia’s central banks have been cutting interest rates for the past nine months. Most of these cuts have worked precisely to offset strong currency policies. If Asia’s currencies had been allowed to weaken six to nine months ago, as they probably should have been, many of Asia’s rate cuts would not have been necessary.
And exports – wouldn’t they be in a much better shape today if Asia’s central banks had more closely followed a Singapore-style basket policy? Probably not. Asia’s exports aren’t in as bad a shape as they appear. They look bad in US dollar terms but, once again, that’s mostly a revaluation effect. If you denominate Asia’s exports in average “tri-currency” terms, exports continue to march ahead in almost a straight-line fashion. This is true for China as it is for India and Singapore. Asia certainly isn’t doing great lately but the export weakness that so many fret about is mostly an illusion – it is just the US dollar once again playing pranks.
