Currency War & Exchange RatesTension!

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Tension over exchange rates


Amid heightened fears over eurozone sovereign debt risks and increasing concerns about the health of the United States and eurozone economies, worried investors have flocked to the safety of haven currencies, especially the Swiss franc, and gold.

While investors and speculators have since moved aggressively to buy gold, the switch from being large sellers to buying by a number of emerging nation’s central banks (Mexico, Russia, South Korea and Thailand) has helped propel the price of gold more than 25% higher this year, hitting a record US$1,920 a troy ounce earlier this month. At a time of high uncertainty in the face of the International Monetary Fund’s (IMF) latest gloomy forecast on global growth, few central banks relish the prospect of a flood of international cash pushing their currencies higher.

Massive over-valuation of their currencies poses an acute threat to their economic well-being, and carries the risk of deflation.

The Swiss franc

Switzerland’s national currency, the CHF, should be used to speculative attacks by now. So much so in the 1970s, the Swiss National Bank (SNB) was forced to impose negative interest rates on foreign investors (who have to pay banks to accept their CHF deposits).

And, it has been true in recent years, with the CHF rising by 43% against the euro since the start of 2010 until mid-August this year. There does not seem to be an alternative to the CHF as a safe haven at the moment.

With what’s going on in the United States, eurozone and Japan, investors have lost faith in the world’s two other haven currencies: US dollar (USD) and the yen.

This reflects the Federal Reserves’ ultra-loose policy stance and the political fiscal impasse in the United States which have scared away investments from the dollar. The prospect that Tokyo might once again intervene to limit the yen’s strength has deterred speculators from betting on further gains from it. To be fair, the CHF has also benefitted from recent signs that the Swiss economy, thanks in large part to its close ties to a resurgent Germany, is thriving.

But enough is enough. SNB made a surprising announcement on Sept 6 that it would buy foreign currencies in “unlimited quantities” to combat a huge over-valuation of the CHF, and keep the franc-euro exchange rate above 1.20 with the “utmost determination.”

On Aug 9, the CHF reached a new record, touching near parity against the euro from 1.25 at the start of the year, while the USD sank to almost CHF 0.70 (from 0.93). The impact so far has been positive: the euro rose 8% on that day and the 1.20 franc level had since stabilised. It was a gamble.

Of course, SNB had intervened before in 2009 and 2010, but in a limited way at a time when the euro was far stronger. But this time, with the nation’s economy buckling under the currency’s massive over-valuation, the risks of doing nothing were far greater. In July last year, following a chequered history of frustrated attempts, SNB vowed it would not intervene again. By then, the central bank was already awash with foreign currency reserves. Worse, the CHF value of these reserves plunged as the currency strengthened. In 2010, SNB recorded a loss of CHF20 billion, and a further CHF10 billion in 1H’11. As a result, SNB came under severe political pressure for not paying the expected dividend. But exporters also demanded further intervention to stop the continuing appreciation.

This time, SNB is up against a stubborn euro-debt crisis which just won’t go away. True, recent efforts have been credible. Indeed, the 1.20 francs looks defensible, even though the CHF remains over-valued. Fair value appears to be closer to 1.30-1.40. But inflation is low; still, the risk of asset-price bubbles remains. What’s worrisome is SNB acted alone. For the European Central Bank (ECB), the danger lies in SNB’s eventual purchases of higher quality German and French eurozone government bonds with the intervention receipts, countering the ECB’s own intervention in the bond market to help weaker members of Europe’s monetary union, including Italy and Spain.

This causes the spread between the yields of these bonds to widen, and pile on further pressure on peripheral economies. Furthermore, unlimited Swiss buying of euro would push up its value, adding to deflationary pressures in the region.

The devil’s trade-off

As I see it, the Swiss really has no other options. SNB has been attempting to drive down the CHF by intervening in the money markets but with little lasting effect. “The current massive over-valuation of the CHF poses an acute threat to the Swiss economy,” where exports accounted for 35% of its gross domestic product. The new policy would help exports and help job security. As of now, there is no support from Europe to drive the euro higher.

SNB is caught in the “devil’s trade-off,” having to choose risking its balance sheet rather than risk “mounting unemployment, deflation and economic damage.” The move is bound to cause distortions and tension over exchange rates globally.

New haven: the Nokkie’

SNB’s new policy stance has sent ripples through currency markets. In Europe, it drove the Norwegian krone (Nokkie) to an eight-year high against the euro as investors sought out alternative safe havens. Since money funds must have a minimum exposure in Europe and, with most European currencies discredited and quality bonds yielding next to nothing, the Nokkie became a principal beneficiary. It offers 3% return for three-month money-market holdings.

Elsewhere, the Swedish krona also gained ground, rising to its strongest level against the euro since June after its central bank left its key interest rates unchanged, while signalling that the rate will only creep up. What’s worrisome is that if there is continuing upward pressure on the Nokkie or the krona, their central banks would act, if needed with taxes and exchange controls. With interest rates at or near zero and fiscal policy exhausted or ruled out politically in the most advanced nations, currencies remain one of the only policy tools left.

At a time of high uncertainty, investors are looking for havens. Apart from gold and some real assets, few countries would welcome fresh inflows which can stir to over-value currencies. Like it or not, speculative capital will still find China and Indonesia particularly attractive.

Yen resists the pressure

SNB’s placement of a “cap” to weaken the CHF has encouraged risk-adverse investors who sought comfort in the franc to turn to the yen instead. So far, the yen has stayed below its record high reached in mid-August. But it remains well above the exporters’ comfort level.

Indeed, the Bank of Japan (BoJ) has signalled its readiness to ease policy to help as global growth falters. But so far, the authorities are happy just monitoring and indications are they will resist pressure to be as bold as the Swiss, for three main reasons: (i) unlike to CHF, the yen is not deemed to be particularly strong at this time it’s roughly in line with its 30-year average; (ii) unlike SNB, Japan is expected to respect the G-7’s commitment to market determined exchange rates; and (iii) Japan’s economy is five times the size of Switzerland and the yen trading volume makes defending a pre-set rate in the global markets well-nigh impractical.

Still, they have done so on three occasions over the past 12 months: a record 4.51 trillion yen sell-off on Aug 9 (surpassing the previous daily record of 2.13 trillion yen from Sept 2010).

The operation briefly pushed the USD to 80.25 yen (from 77.1 yen) but the effects quickly waned and the dollar fell back to a record low of 75.9 yen on Aug 19. But, I gather the Finance Ministry needs to meet three conditions for intervention: (a) the yen/USD rate has to be volatile; (b) a simultaneous easing by BoJ; and (c) intervention restricted to one day only.

Given these constraints, it is no wonder MOF has failed to arrest the yen’s underlying trend. In the end, I think the Japanese has learnt to live with it unlike the Swiss who has the motivation and means to resist a strong currency.

Reprieve for the yuan

I sense one of the first casualties of the failing global economic expansion is renewed pressure to further appreciate the yuan. For China, August was a good month to adjust strong exports, high inflation and intense international pressure. As a result, the yuan appreciated against the USD by more than 11%, up from an average of about 5% in the first seven months of the year. However, the surge had begun to fade in the first half of September.

But with the United States and eurozone economic outlook teetering in gloom, China’s latest manufacturing performance had also weakened, reflecting falling overseas demand.

This makes imposing additional currency pressure on exporters a no-go. Meanwhile, inflation has stabilised. Crude oil and imported food prices have declined, reducing inflationary pressure and the incentive to further appreciate the yuan. Looks like September provided a period of some relief. But, make no mistake, the pressure is still there. The fading global recovery may have papered over the cracks. Pressure won’t grind to a halt.

Central banks instinctively try to ward-off massive capital flows appreciating their currencies. There are similarities between what’s happening today, highlighted by the recent defensive move by SNB, and the tension over exchange rates at last year-end. It’s an exercise in pushing the problem next door.

This can be viewed as a consequence of recent Japanese action (Tokyo’s repeated intervention to sell yen). It threatens to start a chain of responses where every central bank tries to weaken its currency in the face of poor global economic prospects and growing uncertainty. So far, the tension has not risen to anything like last year’s level. But with rising political pressure provoking resistance to currency appreciation, the potential for a fresh outbreak remains real. The Brazilian Finance Minister just repeated his warning last year that continuing loose US monetary policies could stoke a currency war.

Growing stress

With the euro under growing stress from sovereign debt problems, the market’s focus is turning back to Japan (prompting a new plan to deal with a strong yen), to non-eurozone nations (Norway, Denmark, Sweden and possibly the United Kingdom) and on to Asia (already the ringgit, rupiah, baht and won are coming under pressure on concerns over uncertainty and capital flight). Similarly, Brazil’s recent actions to limit currency appreciation highlights the dilemma faced by fast growing economies (Turkey, Chile and Russia) since allowing currency appreciation limits domestic overheating but also undermines competitiveness.

This low level currency war between emerging and advanced economies had further unsettled financial markets.

Given the weak economic outlook, most governments would prefer to see their currencies weaken to help exports. The risk, as in the 1930s, is not just “beggar-thy-neighbour” devaluations but resort to a wide range of trade barriers as well. Globally co-ordinated policies under G-20 are preferred. But that’s easier said than done.

So, it is timely for the IMF’s September “World Economic Outlook” to warn of “severe repercussions” to the global economy as the United States and eurozone could face recession and a “lost decade” of growth (a replay of Japan in the 90s) unless nations revamped economic policies. For the United States, this means less reliance on debt and putting its fiscal house in order.

For the eurozone, firm resolution of the debt crisis, including strengthening its banking system. For China, increased reliance on domestic demand. And, for Brazil, cooling an over-heating economy. This weekend, the G-20 is expected to take-up global efforts to rebalance the world overwhelmed by heightened risks to growth and the deepening debt crisis. Focus is expected on the role of exchange rates in rebalancing growth, piling more pressure on China’s yuan.

Frankly, IMF meetings and G-20 gatherings don’t have a track record of getting things done. I don’t expect anything different this time. The outlook just doesn’t look good.

Former banker, Dr Lin is a Harvard educated economist and a British Chartered Scientist who now spends time writing, teaching and promoting public interest. Feedback is most welcome; email:


Investing in properties beyond our shores

Stories by LIM CHIA YING

In the past, only wealthy Malaysians could afford to buy homes in London, New York and other world leading cities. Today, an increasing number of higher and middle income earners are buying properties abroad.

COMPANY director P.E. Chua bought his first foreign property four years ago, paying A$350,000 (RM1.1mil) for a house in Melbourne, Australia.

“My daughter was seven years old then and I was worried about the 6% annual inflation cost in Australian education. So I thought it would be a good idea to invest in a landed property there instead of another property in KL,” says the 44-year-old.

Chua, who has rented out the Melbourne house, says he has the option of either letting his daughter stay there once she starts her tertiary studies, which could be another six or seven years, or dispose of the property to offset her education costs.

Chua is among a growing number of local investors snapping up properties abroad, finding the prices almost at par with or even lower than those in Kuala Lumpur and Penang where prices have skyrocketed in prime locations.

Apart from Australia, Britain and the United States have also become real estate hotspots for Malaysian investors hoping to spread their property portfolio.

Real estate firms with international partners have been aggressively promoting new housing projects overseas, placing prominent advertisements in local newspapers. Every other weekend, a property showcase or seminar is taking place in the Klang Valley and the crowd that turns up is an indication of the interest shown by local investors to diversify beyond our shores.

Another investor, K. Devaraj (not his real name), says he bought a 600sf studio apartment in central London two years ago for £400,000 (RM1.9mil). He considers the invest­ment worthwhile as the price has since gone up.

“My son needed a place to stay while studying and I bought the place partially for investment,” he says. “I have no regrets as my son may just stay on even after his studies. So, it is likely I will keep the apartment for the long term.”

Like Devaraj, many Malaysian buyers are taking advantage of the current economic situation to pick up some good buys. The interest shown by individual investors is not surprising considering that our Employees Provident Fund has picked up premium British properties worth a total £634mil (RM3.1bil).

On Friday, Star Business reported that Lembaga Tabung Haji and Per­mo­dalan Nasional Bhd are also looking for premium properties for their yield, with London as their first choice, followed by Australian cities.

Henry Butcher Malaysia director Lim Eng Chong says that as local prices get higher for Malaysian buyers, overseas properties are deemed not so pricey any more.

“Apartments in London, for instance, can be quite affordable; in 2009, a unit may just cost £115,000 (RM721,041). The finishing is just as good, if not better than local properties,” he says.

“I think Malaysians have always had a disposable income but it is only in recent times that they have become more savvy.”

Jalin Realty International Pte Ltd chief executive officer Ian Chen concurs, noting that while Malaysians have invested overseas for some time, it is only in recent years that the pace has picked up.

“It makes financial sense for parents to buy a place where their children can stay while studying instead of renting a place. Some already have friends and relatives living in the foreign city, and they ask: why not invest in a unit too,” says Chen.

Established over 30 years ago, Jalin ventured into marketing overseas properties five years ago. Its core market is Australia, where it is partnering conglomerates like Lend Lease, Australand, Frasers Property and other boutique developers to market their properties.

In the United States, the credit crunch since 2008 has led to property prices plunging. With lower prices and a weakening dollar, the US property market has become attractive to foreign investors, among them Malaysians, according to international property investment firm Robert Douglas.

In some places, says its head of sales and marketing (Asia) K. Daniel, prices are so low that one can even pick up a three-bedroom house from RM150,000. A good suburb location would cost RM200,000 onwards compared to RM700,000 back in 2007.

“For that property price, you can get back a monthly rental of between RM900 and RM1,000. Most of our clients are from middle to high income Malaysians, well-educated, aware of the global economic situation, the currency market, have a good investment portfolio and are ready to diversify,” he says.

Henry Butcher Malaysia’s international real estate general manager and business development general manager Jazmine Goh points out that potential customers would usually have done some research themselves or have friends or relatives check out the site.

For first-time investors, she adds, there are rental management experts to assist in managing the property.

Chua admits to being cautious before buying any property. In his case, he relies on Jalin Realty to over­see his Australian investments as he cannot be there physically to handle them.

“Everything has worked out smoothly so far, with the rent banked into my account every month. There is also protection (insurance) against default by the tenant or damage caused and I feel I can better trust the property managers there than here,” Chua shares.

“Owners like us want peace of mind when it comes to rental returns.”

His advice for first-time buyers is that they need to know their objective and reason for investing overseas. Such investments could be made in preparation for their children’s future education or if they plan to retire or migrate, he says.

But Chua cautions against buying to speculate.

“There’s the currency (fluctuations) and other calculated risks to take into consideration and tax rates to be wary of. Buyers should also have holding power to allow enough time for a property to mature. And most importantly, get a trustworthy agent,” he says.

“It can be worth it on a medium to long-term basis, but I would advise against a short-term commitment as property disposal overseas is not that straightforward.”

Chua regards overseas investments like his as affordable so long as it’s dollar-for-dollar and one does not convert.

Another investor, who wishes to be known only as Vincent, says it can be a hassle renting out a house in Malaysia.

“Good tenants are hard to find and you have to personally deal with problematic tenants who give you a headache,” says Vincent, who owns several properties in Australia.

“With overseas properties, you have property managers to handle the lease and there’s protection for owners. Also, I don’t think rental returns here are that good anyway, even in upmarket locales.”

Chen says a huge advantage about property buying in Australia is the reliability of property management there. Property owners need only engage property managers who will help to look for tenants and manage the rental collection and renewal of tenancy agreements.

“There’s also a landlord protection insurance that protects the landlord in the event of loss of rental (delinquency in rental repayment), property damage or theft by the tenant,” he adds.

“Owners can thus invest with peace of mind knowing that the property is protected and in good hands.”

M’sians buying up properties abroad thanks to lower exchange rates


PETALING JAYA: More Malaysians are snapping up properties overseas as they take advantage of the lower exchange rate in countries like Britain and the United States to spread their investments or shop for holiday homes.

A check with several major agents marketing international properties here showed that the number of Malaysian buyers has been climbing steadily over the last three years, peaking in the first half of this year.

With property prices in the Klang Valley and major cities and towns here soaring, those with cash to spare are turning their attention to properties in countries affected by the global economic crisis where prices have dropped.

Among the more popular investment spots are London and its surrounding districts as well as university towns in the US where there is a market for rentals.

Australia, despite its high exchange rate, is also popular due to the good investment returns and stable property market.

Henry Butcher Malaysia director Lim Eng Chong said Malaysian investors were getting more savvy and the buying trend was now heading towards a more global outlook.

“Malaysians and Singaporeans are now the biggest overseas market after the mainland Chinese for prime properties in London,” he noted.

Between January and August this year, the company sold over 100 properties in London, mostly new apartment units to Malaysian buyers. The properties were priced from 200,000 (RM965,382) to 2mil (RM9.65mil) each.

In 2009, about 100 properties were sold while some 150 were sold last year.

“Previously, there was interest but London was out of reach for many Malaysians. Then came the collapse of Lehman Brothers three years ago. The pound became cheaper, spurring more Malaysians to invest there. Many investors would already have enough (properties) on their plates locally, so they are now diversifying,” he explained.

Jalin Realty International Pte Ltd chief executive officer Ian Chen said about 50% of his clients buy homes for their children studying overseas while another 50% buy for investment or to keep as vacation homes.

“We are seeing many young Malaysian professionals investing in Australia, mainly to diversify their investment and to achieve early financial freedom. Australian properties provide much stability and consistenty in capital growth, with about 10% annual compounding growth,” Chen added.

He said sales had shot up 100% since the company ventured into the overseas market five years ago. Most of the properties sold ranged from AUD500,000 (RM1.57mil) to AUD800,000 (RM2.5mil).

International property investment firm Robert Douglas head of sales and marketing (Asia) K. Daniel said US properties in Michigan, Florida and Las Vegas were now popular, as they yielded high returns. Michigan and Florida were attractive because of their high student population which provided a ready market for rental properties.

“Malaysians usually buy to let (for rental returns). But if they wish to stay, there are no restrictions as long as they have the necessary visa, ” Daniel pointed out.

Malaysians who want to invest are advised to consider all aspects


PETALING JAYA: Malaysians who wish to invest in overseas properties have been advised do their homework first.

This is because they could be subjected to high government levies and taxes in cities where the properties are located, said Real Estate and Housing Developers’ Association Malaysia president Datuk Seri Michael Yam.

Yam also cautioned against buying for speculation, saying buyers had to consider currency risks.

They must also be aware that under a Bank Negara ruling, any large sum of money outflow must be reported and buyers should not have any borrowings with local banks.

Yam is however not perturbed over the global buying trend, saying it would not have much significance on the local property market as the primary homes for these investors would still be in Malaysia.

“While we try to attract foreign investors to invest here, we should not stop and discourage Malaysians from investing overseas,” he added.

Association of Valuers, Property Managers, Estate Agents and Property Consultants in the Private Sector Malaysia president Choy Yue Kwong said properties in Britain, especially London, were now popular because of the relatively “low” pound.

“As long as the exchange rate is in our favour, Malaysians will continue to buy (properties overseas),” he added.

Realities about China’s BoP surpluses

We need to go back to fundamentals to get a better perspectives

RECENTLY, I was in Shanghai to attend a research symposium led by Harvard president Drew Faust. Participants included the university’s best and brightest China-hands as well as luminaries from among China’s elite academia.Deliberations took on “The Chinese Century?”, “China: Dynamic, Important and Different”, “The Moral Limits of Markets”, “Managing Crises in China” and many more. I came away wiser. Indeed, there is so much happening in China to experience, understand and learn.

Visiting Shanghai and Beijing, you cannot but feel China is under siege for running external payments surpluses. A consequence – argued by politicians and others in the United States and Europe, of China’s rigid exchange rate regime.

The debate is as fierce as it is emotional. Of late, China is strongly criticised for artificially depressing (even manipulating) the value of its currency, renminbi or yuan, to the detriment of its trading partners. Indeed, Nobel Laureate Paul Krugman even contended that China had since taken millions of jobs globally, especially from the United States.

To really understand this it requires going back to fundamentals. What caused China’s recent balance of payments (BoP) surpluses?

Causes of imbalance

For China, BoP surpluses are a relatively recent phenomenon. It used to have persistent deficits in the second half of the 80s. Surpluses only came in the early 90s and rose sharply since 2004 (3.5% of GDP or gross domestic product) to reach a high in 2007 (10.8%). The surplus has now moderated but only modestly.

Whereas, serious US current account deficits started years earlier. The literature on China’s surpluses is long. I came across a perceptive study by two young Beita economists at its China Centre for Economic Research, Huang Yiping and Tao Kunyu, who attributed the main cause to asymmetric market liberalisation.

Over the past 30 years, reform was much too focused on product markets (today, 95% of products are determined by free markets). But markets in factors of production – labour, capital, land, energy and the environment – remain highly distorted, driven by the government’s growth-centered policy strategy to push exports.

These cost distortions are equivalent to production and investment subsidies. Both Chinese and foreigners invest massively because of China’s cheap labour, cheap capital, cheap land and cheap energy:

● Labour: China’s abundant and cheap labour is key to its continuing success in manufacturing exports. But labour costs are distorted because (i) the separation of rural and urban labour leads to labour immobility and low pay for rural migrants; and (ii) an out-of-date social welfare system (including health and pensions) means payrolls should be 35%–40% more.

● Capital: The financial system remains repressed, with regulated interest rates and state control of credit allocation; external capital controls are restrictive on outflows. Moreover, the currency is kept undervalued.

● Land: The state owns land in cities and collectives, outside. No market mechanism exists to price land for industrial use; often prices are set low to promote investment and growth.

● Energy: Key energy prices are state-determined and usually subsidised; and

● Environment: Enforcement is random since growth is a given priority. The cost of pollution is not priced in.

All these mean lower production costs and producer subsidies. They artificially inflate profits, raise investment returns and improve competiveness. Economists Huang and Tao estimated these subsidies to be worth a hefty 7% of GDP.

Capital market distortions are the most troublesome, contributing 40% of total; with labour subsidies, 25%. The upshort: These are structural imbalances. Factor distortions are deep. Any credible policy at re-balancing must tackle the root cause, i.e. distorted incentives for investors, producers and exporters. The undervalued yuan is but one element in the entire jigsaw.

The savings-investment gap is by definition the flip-side of BoP surpluses. Attempts to explain the imbalance in terms of savings and investment behaviour will not be useful. Suffice to recognise the common belief that Chinese households save too much is incorrect.

For 15 years, the household savings rate has been stable at about 30%; nothing unusual in Asia. Its stability suggests that household savings are probably not a key cause of the growing BoP surpluses in recent years. Because corporate savings are rising, households’ income share is on the decline.

The exchange rate option

Exchange rate reform in China is sensitive. For the United States and Europe, the yuan scapegoat is political football, with attendant risks of a trade war. Among economists, there are vast differences about what needs to be done. The common prescription is to let the yuan rise by a certain margin (enough to eliminate the undervaluation), but no one knows precisely what this is. Views vary widely.

In April, Goldman Sachs pointed out that “at the moment, rather oddly, our model suggests that the RMB (yuan) is very close to the price that it should be. This has not always been the case. The model used to suggest the currency was undervalued by about 20% but it has moved by that degree over the past five years.”

However, a 2009 research of Goldstein and Lardy at the US Peterson Institute pointed to a 12%–16% undervaluation. Even if such an adjustment were taken, the West would still prefer it to be larger. Nor will the Chinese do so in one go, given the likely sharp negative impact on China’s desire for exchange stability.

But the weight of recent history looms large. Between the mid-2005 and end-2008, the yuan exchange rate appreciated by 19%, after strengthening by 30% over 10½ years since January 1994. Yet China’s BoP surplus surged during these periods. Despite the revaluation, US-China imports rose 39% during 2005–2008.

Japanese economic stagnation following the US pressure in 1985 didn’t boost confidence – US$1 fell from 240 yen to 160 yen over two years; and then to 80 yen by 1995.

Consequently, growth slowed abruptly forcing more government spending and low interest rates. The real-estate bubble and a year-long slump followed. The 1990s became a decade of lost growth. To this day, the intended aim to fix Japan’s BoP surplus remains just that – an empty aim!

Two lessons have emerged for China: large foreign exchange adjustments cause long-term damage to the economy, and it won’t necessarily help eliminate BoP surpluses.

An often suggested alternative is for China to adopt greater exchange rate flexibility. This looks reasonable enough, but will it resolve China’s BoP imbalances? Empirical studies have shown there is no systematic or reliable relationship between its BoP position and exchange rate flexibility.

Consider this also. Even if a significant yuan revaluation could wipe off China’s BoP surpluses, it still won’t reduce the United States’ BoP deficits. After all, yuan features at only 15% of the US Federal Reserve’s exchange rate basket for the greenback. This simply means a 20% yuan appreciation only translates to a 3% appreciation against the dollar.

Furthermore, the market vacuum left by China would most likely be filled by exports from other low-income countries like India, South Africa, Indonesia and Vietnam, or by even high-tech competitive South Korea and Taiwan. So be careful about what you ask for.

And then, there is the crawling peg or gradual appreciation option. But this creates expectations that can lead to speculation and hot-money inflows. China should have learnt from yuan’s rise in 2007 and 2008. A way out of this dilemma should be familiar: Opt for the compromise it took in July 2005 when China moved off the peg to the US dollar with a material revaluation, which eventually turned out to have little impact on its BoP surplus.

Unlike the United States and Europe, ASEAN plus 4 (India, Japan, South Korea and Taiwan) have remained “cool” on this issue because: (i) China’s continuing growth provides a robust source of demand for the region; (ii) most neighbours have different export profiles from China; indeed, most of their trade complements rather well; (iii) Japan, South Korea and Taiwan have built large manufacturing capacities in China, thus sharing in China’s dynamic exports; and (iv) Asia likes ready access to cheaper manufacturing equipment it badly need, which in turn keeps China’s export machine running.

In the final analysis, many in Asia are likely to mirror any revaluation of the yuan. This is already happening to the stronger Asian currencies as the US dollar weakens.

US unlikely to benefit

Students of economics know better. In the past two years, the United States had trade deficits with over 90 countries. Yet, the United States is pushing for a bilateral solution (“forcing” China to revalue or tax Chinese exports) to essentially a multilateral problem. Both China and the United States have large imbalances with rest of the world. Any credible solution must lie in a multilateral approach. After all, China-US trade accounted for only 12% of the total Chinese trade.

Nevertheless, empirical evidence suggests that a more expensive yuan is unlikely to reduce the US bilateral deficit. A sharp appreciation of the yuan between June 2005 and June 2008 in fact widened the US deficit. Contrary to textbook economics, US imports from China rose by 39%, offsetting increases in China’s US-imports which (even without revaluation) had been increasing since 2002.

Moreover, higher import prices would mean a fall in the purchasing power of US income. But a stronger yuan raises the purchasing power of China’s producers who rely on imported raw materials. Because imports are now cheaper, Chinese exporters can reduce export prices to maintain market share.

Realistically, it is not surprising that the relationship between the exchange rate and BoP balance is at best weak. Weaker still is the relationship between the BoP deficit and US job loss.

Here again, empirical evidence is telling. An old friend, Prof Lawrence Lau of Stanford, pointed out in his 2006 research (and corroborated by others in 2008) that Chinese value-added accounted for only 1/3 to ½ of US imports from China. This reflects the importance of efforts by workers and capital from other countries, including the United States.

It is reported the iPod costs US$150 to produce, of which only US$4 is Chinese value added. Most of the components are made in the United States and other countries. It is put together in China and exported to the United States for the full US$150 as imports from China, adding to the US deficit and exaggerating the US job loss!

In reality, imported iPods support a myriad of US jobs up the value chain. Surely, prohibitive tariffs on iPod imports can’t really hurt China. Why cut your nose to spite your face?

China needs a package deal

It does appear slamming China as a “currency manipulator” does not help the United States’ cause. It will probably backfire. Even assuming the yuan is undervalued, exclusive focus on China’s exchange rate policy is, I think, counter-productive. It will unlikely resolve the United States’ persistent external imbalance.

However, as I see it, there is growing awareness in Beijing that greater exchange rate flexibility and a gradual yuan appreciation has to be an element of any credible package of policy measures for China to seriously liberalise factor markets and remove cost distortions. This could well transit over time to a full-market economy. Any exchange rate adjustment has to be viewed in this context.

Nevertheless, these are necessary but not sufficient. China has to embark also on other reforms, including re-designing macro-economic policies that don’t over-emphasise growth, privatising state-owned enterprises and liberalising financial development, striking a better balance in income distribution from corporate to households, and aggressively promoting the services sector development, especially small and medium-scale enterprises. Such a comprehensive rebalancing exercise can be made to work, but will necessarily take time. It’s steady as she goes.

What Are We To Do by TAN SRI LIN SEE YAN

Former banker, Dr Lin is a Harvard educated economist and a British Chartered Scientist who now spends time teaching and promoting the public interest. Feedback is most welcome; email:

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