Japan’s And China’s Falling Currencies Should Raise Concerns For Asian Markets

Japanese yen and Chinese yuan are as different as chalk and cheese. The yen floats freely and the renminbi is tightly controlled. But with the dollar strengthening in Asia on Fed tightening, central banks in Tokyo and Beijing find themselves on the same path to keeping monetary policy accommodative.

For very different macroeconomic reasons, the Bank of Japan and the People’s Bank of China loosened their grip and seemed content to see their currencies weaken sharply against the dollar. But loose monetary policy in the region’s two largest economies will be a concern for the rest of Asia, which has been raising interest rates amid capital outflows and a rising dollar. A devaluation of the renminbi, in particular, would undermine the competitiveness of competitors’ exports and could trigger a wave of competitive devaluation.

Of course, the yen is the poster child for currency profligacy. Since 2013, the Bank of Japan, led by Governor Haruhiko Kuroda, has bravely attempted to stem a prolonged slide in consumer prices by injecting the financial system with an estimated $5 trillion in easy money that exceeds the country’s GDP. The main objective of this easing is to influence consumer and business behavior to accommodate two decades of deflation and push inflation above the Bank of Japan’s 2 percent baseline range.

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Kuroda said on Oct. 24: “Stable inflation at our 2% target with rising wages is desirable.” Meanwhile, the Bank of Japan has been closely watching the yen’s fall to a record low of 150 against the dollar and The market has been disrupted by intervening in the foreign exchange market to stem the slide.

Japan’s two close neighbors, South Korea and Taiwan, are bearing the brunt of the Bank of Japan’s bold attempt to influence price action. That’s because the troika manufactures and exports high-end electronics and cars, so a weak yen provides Japanese manufacturers with a significant price advantage. To be sure, the Korean won has also depreciated against the dollar this year (by an estimated 15%, while the yen has lost 20%). The risk to regional economic stability stems from the Bank of Korea’s acceptance of the theory that the won will depreciate under pressure from South Korean exporters.

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These risks are magnified when China and a weaker yuan enter the conversation. While Japan is deeply integrated into Asian manufacturing, supply chains are often bilateral. Southeast Asian manufacturers are not inclined to compete with Japanese companies in the global market. But this is not the case in China, which is deeply integrated into regional supply chains as the final assembly point for products destined for world markets.

Most components come from this region, and China is also a competitor to the rest of Asia in other products and services. While the yuan’s weakness is more cautious than the yen’s depreciation, it has the potential to destabilize the region if the People’s Bank of China allows the yuan to depreciate further.

Chinese policymakers are worried about an economic slowdown, with the International Monetary Fund forecasting GDP growth of just 3.2 percent this year, a multi-decade low. The slowdown has largely been attributed to stifling coronavirus restrictions, but with President Xi Jinping already in his third term, Chinese officials may be inclined to ease conditions further.

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In previous volatile economic events, such as 1998 and 2008, China positioned itself as a regional leader by not letting the yuan depreciate. The rest of Asia expects the PBOC’s magnanimity to remain unchanged. However, there is no regional forum where Asian central bankers can sit down and discuss the cross-border implications of monetary policy. In theory at least, central bankers would say such forums exist, but rarely raise tough topics.

To be fair to the People’s Bank of China and the Bank of Japan, the Fed does not understand the global impact of its policies, which has had a negative impact on emerging markets around the world. As far as Asia is concerned, it has felt the second-round effects of US monetary policy through easing in two systemically important countries. China and Japan should demonstrate regional leadership by curbing the devaluation of their currencies and promoting regional economic stability. If they fail, it will almost certainly lead to a regional currency war.

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