10 years on, currency earthquake is waiting to rattle Asia once more


It is 10 years since the Asian currency crisis. Currency crises are like earthquakes. I hesitate to use this analogy when lives have been lost and people continue to suffer as a result of the quake last week in the Chuetsu area of Niigata Prefecture. Yet the parallel is a valid one.

A sudden and violent realignment of currency values destroys people’s assets. What was seemingly a mound of gold turns into ashes in a flash. The erstwhile wealthy become poverty-stricken overnight. Aftershocks are liable to strike when they are least expected. It takes time to recover from the destruction that the shock waves cause. Normal life does not resume that easily in the wake of currency turmoil.

Can it happen again? And if so when, and under what circumstances? As with earthquakes, none of these questions is easy to answer with any amount of accuracy. The majority view seems to be that the risk of a reoccurrence is a small one, given that East Asians have learned their lesson well, their foreign exchange reserves are running at unprecedented levels and their financial markets have become altogether more sophisticated. These are all reasonable arguments against the possibility of another currency shock wave emanating from East Asia. The Asian landscape does indeed look a lot healthier than 10 years ago.

Yet appearances can be deceptive. Fault lines that are not immediately visible may be doing a lot of seismic mischief unbeknown to the locals. The landscape may have changed but there is one significant aspect of the whole picture that is very conspicuous for its unchanging presence. This is the Japan money factor. Now as then, yen-carry trades are all the fashion.

Now as then, funds can be raised for next to nothing in Japan. Now as then, that cheap Japan money is finding its way into all sorts of high interest rate places. Now as then, the flow can be reversed at any time. In this respect the fault lines are startlingly similar to those of a decade ago. Indeed, the situation is arguably more vulnerable today, since the number of people indulging in carry trades has grown considerably larger between then and now. They are also a more diverse group. Then it was mostly professionals who were doing the carrying. Now more and more ordinary people seem to be trying a hand at the yen-transportation exercise. This is with good reason since their savings gain them more or less nothing so long as they stay stuck in Japan. Japan money can only become profitable once it is carried out of Japan. To the extent that these mechanics remain intact, the situation is fraught with tension.

So the answer is quite simply yes, it can happen again. It is actually difficult to see how it can be avoided given the persistence of carry trades. What got carried away has to be brought home some time. And when Japan money does eventually come home, the process will inevitably cause tremors wherever the epicenter happens to be at the time.

Abnormally low Japanese interest rates push Japan money out of Japan. That Japan money in exile causes the fault lines to deepen, thus raising the prospect of the next earth-shattering realignment of currency values. This being the situation, the obvious solution is for Japanese interest rates to rise to more normal levels. Yet herein lies the catch. Japan cannot raise interest rates without causing the very turmoil everybody hopes to avoid. At a mere whiff of higher Japanese interest rates, the flow of funds out of Japan will be reversed, in a repeat performance of 10 years ago. Catch 22s cannot get much worse.

Noriko Hama is an economist and a professor at Doshisha University Graduate School of Business.