Fri, 24 Oct 2008

The coming wave of competitive devaluations in Asia

We are today seeing a significantly altered re-run of the 1997 crisis in large parts of Asia. Once again, there is a “sudden stop” and reversal of capital flows. The big difference is the the large reserves that Asian countries accumulated during the crisis.

Korea was the first to realize a few weeks ago that unless they threw the reserves away in a futile defence of the currency, the reserves were large enough to cover the sovereign debts as well as the debts of the banking system. A crashing currency could bankrupt reckless companies, but the country would be safe. They have therefore let the currency collapse and have been free to use the reserves to lend to their over extended banks. In 1997, Asians did not have this option. They thought that the only way to prevent a run on the country was to defend the currency and signal to the rest of the world that they were sound.

I believe that the Korean currency depreciation of recent weeks is going to be the new pattern in Asia. Under normal conditions, most Asian governments are suborned by their corporate sectors, but under conditions like this, these same governments would let reckless companies stew in their own brew. An added incentive this time is that with a slowing global economy, the Asians are going to be fighting for a share of a shrinking export pie. We will therefore see more of the beggar thy neighbour game that the Europeans and Americans played during the great depression. This time around, the western world does not seem inclined to play this game leaving the field wide open to the Asians.

We in India know how ten years ago the Koreans used their depreciated currency to capture the white goods market in India. Now that the won is again at 1400 (closer to 1450 as I write) to the dollar, I see an even bigger onslaught by the Koreans because the best run conglomerates are in far better shape than they were in 1998. It will not just be white goods but every industry where there is global excess capacity (which probably means just about everything).

The won will also put pressure on Japan to embark on large scale intervention (possibly half a trillion dollars over the next year or so) to keep the yen down. The Japanese are possibly more concerned about the euro-yen cross today and their intervention could indirectly help the Europeans. But the Chinese would feel the heat of a declining won and yen.

For a couple of months now, the smart money has been shorting the renminbi (what a change a few months makes!). As Chinese exports slow down, a depreciation of the renminbi would be just what the doctor ordered. Since probably as much as half a trillion dollars of hot money flowed into China in the last couple of years, the Chinese government would just have to sit back and watch this money flow out and pull the renminbi down as it leaves. I would not be surprised if a year from today, Japan once again has the world’s largest foreign currency reserves.

Competitive devaluation by Korea, Japan and China would leave India with no choice but to let the rupee fall to levels which would be frightening (if not bankruptcy threatening) to those who have been stupid enough to borrow in dollars. Beggar thy neighbour is a very ugly game when countries start playing it in right earnest.

Posted at 11:35 on Fri, 24 Oct 2008     5 comments     permanent link

Comments...

kumar wrote on Fri, 24 Oct 2008 17:15

Re: The coming wave of competitive devaluations in Asia

Competetive devlauation amonst China, Japan and Korea is comprehensible as these countries compete in the manufactured goods space but why should India get in to this game? as India is a marginal player in those markets.

HB wrote on Sat, 25 Oct 2008 12:55

Re: The coming wave of competitive devaluations in Asia

Professor Verma, I think this theory would probably work well in a market where there is sufficient global demand to spur "beggar thy neighbour". Despite free markets, don't there exist alternate means of protectionism - quality control for example - too much lead in the white paint, maybe ?

genuine_optimist wrote on Sat, 25 Oct 2008 12:02

Re: The coming wave of competitive devaluations in Asia

Countries with significantly larger exports/GDP will use currency depreciation to maintain their economies. So South Korea and China can resort to this strategy.

However for India which requires foreign money for investments (both as equity and debt) & imports, a steadily depreciating currency is bad. It will cause higher inflation and lesser dollar inflows, leading to higher interest rates and economic downturn.

Dear Prof, your analysis appears right for South-East asian tiger economies, but I think its too early to say what will happen to Re and Renmibi. Domestic investment and growth climate will decide Indian monetary policy. 2009 will have a new government at the helm and much depends on politics as well. Even in normal times, predictions on interest, x rates are tough. These are different times and I don't know how anyone can predict! :-)

Gaurav wrote on Sat, 25 Oct 2008 11:14

Re: The coming wave of competitive devaluations in Asia

Devaluation, but against which currency? It is not in the best interests of US also to let the dollar keep appreciating beyond a point - export growth was what kept US out of a recession this year. While a high dollar helps US keep inflation low and finance its huge deficit going forward, it will also exacerbate their unemployment problem.

So, if the assumption is dollar appreciates, it will also imply rising trade barriers in the US going forward. Their politicians already find it hard to explain the financial mess to voters. Voters will get even more angry if Korea takes away more jobs (particularly in auto).

Gaurav

andiron wrote on Mon, 24 Nov 2008 05:13

Re: The coming wave of competitive devaluations in Asia

Mr varma is amongst the few in india who have overcome the mungerilal syndrome that afflicts a large section of indians (10% that benefitted from global credit orgy)Like greennspan said it was one off event and mungerilals started conjuring up delusions of grandeur. W/ outsourcing bust looming, it will impact indian realestate bubble even more. Since indians, for the first time, will experience the downside of capitalism as large scale layoffs loom next year , it will be interesting to see how the govt reacts & if nascent efforts to open economy get stymied. GDP growth will dip 2-5% in the next 5 yrs Rupee will fall to 75 against dollar Tata motors can become bankrupt. IT lanscape will change completely.