In my last post, I argued that Asian currencies are likely to witness a round of competitive devaluations. The purpose of this post is to consider whether this could be accompanied by a fiscal binge as well.
But first some elaboration of my two fold argument for Asian devaluations. The first part of the argument is that reserves are large but not infinite – reserves may be drained rather quickly if the country tries to defend the currency. The Koreans found this out quickly. (My definition of Asia does not include Russia, but the Russians may also be in the same boat right now. Their half trillion dollar reserves are the third largest in the world, but they have already lost a tenth of it and clearly, this rate of reserve loss can not last forever).
Faced with this reality many countries will let the currency find its level and let the rest of the world deal with its consequences. Korea is today telling the rest of Asia what US Treasury Secretary, Jim Connally told his European counterparts back in the 1970s: “The dollar may be our currency, but it is your problem.” The added twist is that Korea is also telling its own corporate sector that the won is their problem, not that of the government. Many Asian companies will hear the same message. Any emerging market company with lots of foreign currency debt will lilkely find itself staring into the abyss.
The second part of the argument was that faced with a global recession that threatens to be a global deflation, currency depreciation becomes a desparate attempt to maintain exports. Commentators on my earlier post asked whether this can succeed. Of course, beggar thy neighbour cannot succeed if everybody tries it as the world found in the great depression, but that does not prevent everybody from trying it.
There will therefore be two kinds of currencies – those that are taken down by the markets and those that are taken down by their own governments. Some currencies will be somewhere in between – the markets will begin the job and the governments will finish it.
Now back to the fiscal implications. During the 1997 crisis, the discipline of currency markets was a strong factor in favour of fiscal restraint. This time around, that restraint will be lacking. In fact, the governments will be tempted to use fiscal boosts to lift the economy out of recession. Two statements from the just concluded Seventh Asia-Europe Meeting were interesting in this regard:
- Indian Prime Minister Manmohan Singh stated quite bluntly: “As a counter cyclical device, increased infrastructure investments in developing countries, if backed by increased resources flows from multilateral financial institutions such as the IBRD and Regional Development Banks, can act as a powerful stabilizer.” India has still not let go of its currency and so the call for support from the world bank makes sense. But the day the government decides that the rupee is somebody else’s problem, this support will be less important. Elsewhere in his speech, Dr Singh also quoted Keynes with approval.
- The statement of the Seventh Asia-Europe Meeting on the International Financial Situation contains this line: “Leaders called on all countries to pursue responsible and sound monetary, fiscal and financial regulatory policies, enhance transparency, inclusiveness, strengthen oversight, and improve crisis management mechanisms so as to maintain their own economic development and the stability of the financial markets.” This was remarkable for not talking about price stability or orderly exchange rates. One could argue that financial markets include currency markets, but in today’s context, the terms refers more to credit markets.
The fiscal binge (particularly when financed by the printing press) is just the currency debasement strategy applied internally rather than externally. It is a very powerful weapon against “debt deflation”, but the remedy can sometimes be worse than the disease.
Can the fisc substitute for the lost foreign demand? The fisc is ill suited to buying the stuff that Asia is used to selling to the now retrenching American consumer. The fisc is best suited to building roads to nowhere providing some support to the steel and cement industries which are now gasping for breath.