Recent currency rallies across Asia make zero sense, especially considering how central banks are increasingly heading in that direction — and beyond.
Consider South Korea, which led the pack in March with an 8 percent surge. Slowing economic growth? Accelerating disinflation? A sudden bubble in North Korean missile launches? Nothing, it seems, can keep the won down. Or take Malaysia, site of Asia’s most troubling corruption crisis involving $700 million found in the prime minister’s bank account. Intrigue in Putrajaya didn’t stop the ringgit’s inexplicable 7.8 percent jump in March, the biggest since Malaysia’s last brush with political chaos in 1998.
The yen has been on an upward tear of its own. Never mind that the economy is sputtering, wages are flat and the Nikkei is tanking — the Japanese currency is a buy. Even the Thai baht is booming as the military junta shooting one of Southeast Asia’s most promising economies in the foot shows no sign of holding elections.
What accounts for this March madness in foreign exchange circles? Much of the disorientation reflects three bits of conventional wisdom being turned on their heads. One, the Federal Reserve won’t be tightening much in 2016 after all. Two, China hasn’t devalued the yuan, as many feared. Three, commodities didn’t just stop falling — they’re waging a modest comeback. But looked at logically, none of these conditions supports higher Asian currencies in the months ahead. In fact, the opposite may be true.
The Bank of Japan, for example, is almost certain to open the monetary spigot wider than ever as growth disappoints, perhaps later this month. The same goes for the People’s Bank of China, which is fighting an ever-growing number of headwinds from all directions.
Asian exports, remember, aren’t exactly thriving at the moment. They dropped 8.2 percent in South Korea alone in March, following a 12.2 percent plunge a month earlier. As the BOJ and PBOC step on the monetary gas anew, expect aggressive efforts to cap currencies throughout the region. Sure, the International Monetary Fund will certainly protest and economists will buzz about “currency wars,” but flagging global demand raises the odds devaluation fever will sweep Asia.
China’s slowdown has only just begun and its fallout will be bigger than trading partners realize, says Andrew Batson of GaveKal Research. While Beijing is indeed rebalancing growth engines, Batson says, “the consumption share of the economy is rising, and the investment share is declining, overall growth is still declining. Investment growth has slowed sharply, which has hurt the industrial sector and corporate profits. This in turn has led to a slower pace of job creation and wage growth, which in turn feeds into a slowdown in household consumption.”
That matters for the rest of the world because Beijing’s investment programs tend to benefit Chinese import activity more than domestic consumption. As such, Batson says, “a Chinese economy that is both slower-growing and more consumption driven contributes less to global growth than one that is faster-growing and more investment driven. For most countries the gains from rising Chinese consumer spending are therefore likely to be relatively small compared to the impact of the slowdown in Chinese investment.”
And then there’s Japan, where the Nikkei is getting clobbered (down 15 percent so far this year) and officials are scrambling to avoid yet another recession. There’s also increasing evidence that the BOJ’s negative interest-rate policy is backfiring. Rather than strong-arming bankers to lend more, the market for overnight loans is drying up. Long-term bond yields are heading lower, too, suggesting traders doubt Gov. Haruhiko Kuroda’s gambit will work. As Tokyo markets malfunction, thanks partly to BOJ policies, companies may grow even more timid about boosting wages or retaining staff.
That upshot is another round of quantitative easing that drives down the yen — perhaps massively. In February, exports fell for a fifth straight month, slamming the one element of Prime Minister Shinzo Abe’s revival program gaining traction. Yen bulls could be in for a rough 2016 as the BOJ moves even further into uncharted monetary territory. The latest tankan business confidence survey displayed very little of it. And things are only getting worse.
That could increase the odds the Bank of Korea slashes rates, too. The minutes from the BOK’s February policy meeting suggested mounting pressure for lower borrowing costs, well ahead of the March won rally. Central banks across the region may do the same.
Greece’s return to the headlines couldn’t come at a worse moment for Asia. As Athens and the International Monetary Fund square off on adherence to the nation’s bailout program, we’re reminded that the eurozone still hasn’t addressed existential questions about its stability, so much as tossed money at them. The last thing markets want is a fresh contagion trade that whipsaws emerging markets and further complicates the outlook for Asia’s two biggest economies. Not to mention the United States, where the post-2008 recovery has been unsteady.
Asia’s emerging economies have tremendous potential with growth rates of which developed ones can only dream. But looking at where China and Japan are headed, there’s nothing about today’s huge currency rally that computes.
William Pesek, executive editor of Barron’s Asia, is based in Tokyo and writes on Asian economics. www.barronsasia.com