This is not America
Sep 24th 2004 From The Economist Global Agenda
Sep 24th 2004 From The Economist Global Agenda
As the Federal Reserve continues to tighten America’s monetary policy, will central banks in East Asia follow suit?
AMERICAN interest rates exert a gravitational pull over global capital, which emerging markets find hard to escape. When interest rates are low in America, investors flock to emerging markets in search of higher yields. But when the Fed nudges rates up, as it did for the third time in three months on Tuesday September 21st, the flow of capital to emerging markets normally ebbs, forcing their central banks to raise interest rates if their currencies are not to fall.
But in this tightening cycle, the emerging markets of East Asia are enjoying some unaccustomed room for manoeuvre. The “automatic” link between their rates and American rates is slipping, argues Julian Jessop of Capital Economics, a consultancy. Hong Kong, which maintains a hard peg to the dollar (backed by a currency board), will have to raise rates, but South Korea has already cut them once this year and may do so again (see chart). Taiwan may raise rates by a quarter of a percentage point, but seems in no great hurry. Meanwhile, the monetary authorities in China, the most closely watched emerging market of all, seem determined not to be rushed into anything.
East Asian currencies are certainly under pressure at the moment. But the pressure is upward. This has yet to show up in their exchange rates. The Malaysian, Chinese and Hong Kong pegs to the dollar have held firm. The Singaporean and Taiwanese dollars have strengthened slightly against the American variety in the past year, as has the South Korean won, but the monetary authorities in each of these countries have resisted any strong upward movements in their currencies.
Suppressed in the currency market, this pressure to appreciate shows up instead in the current-account surpluses these economies run and the mountain of dollar reserves they have amassed. Their combined current-account surplus amounted to well over $100 billion last year and their hoard of reserves is currently worth about $1.2 trillion.
In short, East Asia is becoming a region of dollar creditors, not dollar debtors. Singapore, Taiwan and China have long enjoyed this position; South Korea and Malaysia, however, were chronic borrowers until their financial crises in 1998. Since then, they have embraced the virtues of thrift, saving more than they invest each year, and parking the excess in copper-bottomed dollar assets.
The Chinese authorities alone now hold $483 billion in reserves, much of it in American Treasury bonds. They will meet the man who has written all those IOUs next week in Washington, when, for the first time, Chinese officials will be invited to join John Snow, America’s treasury secretary, and the other finance ministers from the G7 group of rich nations, at one of their annual summits.
The meeting will be tense, because America is a remarkably ungrateful debtor. Instead of thanking China for buying its assets, it denounces it for not buying enough of its goods. It complains that China’s exporters are stealing a march on its own manufacturers and demands that the Chinese revalue the yuan to dull their competitive edge. Mr Snow will repeat this call next week, urging the Chinese to introduce more “flexibility” in their exchange-rate arrangements. A truly flexible exchange rate can move either way, of course. Mr Snow only cares that China’s moves up.
China faces a dilemma common to all the dollar creditors in the region, argues Ronald McKinnon of Stanford University. If they let the dollar fall against their currencies, they would suffer a capital loss on their holdings of dollar assets. A cheaper, more competitive dollar is a boon to the American manufacturer, but a bane to the holder of dollar assets. Indeed, the very fear of such a capital loss can bring it about, if it prompts private holders of dollars to flee from the greenback into the domestic currency. In East Asia, emerging markets have almost as much to fear from a run into their currencies as from a run on them.
In China, despite its thicket of capital controls, speculators have already placed bets on a revaluation of the yuan. The authorities have kept a peg of 8.28 to the dollar since 1994. But though the yuan’s value abroad has remained rock-steady, its value at home has slipped. Inflation is now running at 5.3% per annum. In the past, the People’s Bank of China has talked about raising interest rates if inflation crossed the “bearable limit” of 5% (real rates—ie, adjusted for inflation—are now zero). But to do so would invite further speculative flows into the yuan.
Which brings us back to the Fed. As it raises interest rates, American assets will yield better returns. This will encourage holders of these assets to keep them, rather than dumping them in favour of yuan, won or ringgit. Thus, a tighter monetary policy in America will relieve some of the upward pressure on the currencies of East Asia. In the months ahead, the monetary authorities of emerging markets will be watching the Fed as closely as ever. But this time they may not scurry to follow its lead.
But in this tightening cycle, the emerging markets of East Asia are enjoying some unaccustomed room for manoeuvre. The “automatic” link between their rates and American rates is slipping, argues Julian Jessop of Capital Economics, a consultancy. Hong Kong, which maintains a hard peg to the dollar (backed by a currency board), will have to raise rates, but South Korea has already cut them once this year and may do so again (see chart). Taiwan may raise rates by a quarter of a percentage point, but seems in no great hurry. Meanwhile, the monetary authorities in China, the most closely watched emerging market of all, seem determined not to be rushed into anything.
East Asian currencies are certainly under pressure at the moment. But the pressure is upward. This has yet to show up in their exchange rates. The Malaysian, Chinese and Hong Kong pegs to the dollar have held firm. The Singaporean and Taiwanese dollars have strengthened slightly against the American variety in the past year, as has the South Korean won, but the monetary authorities in each of these countries have resisted any strong upward movements in their currencies.
Suppressed in the currency market, this pressure to appreciate shows up instead in the current-account surpluses these economies run and the mountain of dollar reserves they have amassed. Their combined current-account surplus amounted to well over $100 billion last year and their hoard of reserves is currently worth about $1.2 trillion.
In short, East Asia is becoming a region of dollar creditors, not dollar debtors. Singapore, Taiwan and China have long enjoyed this position; South Korea and Malaysia, however, were chronic borrowers until their financial crises in 1998. Since then, they have embraced the virtues of thrift, saving more than they invest each year, and parking the excess in copper-bottomed dollar assets.
The Chinese authorities alone now hold $483 billion in reserves, much of it in American Treasury bonds. They will meet the man who has written all those IOUs next week in Washington, when, for the first time, Chinese officials will be invited to join John Snow, America’s treasury secretary, and the other finance ministers from the G7 group of rich nations, at one of their annual summits.
The meeting will be tense, because America is a remarkably ungrateful debtor. Instead of thanking China for buying its assets, it denounces it for not buying enough of its goods. It complains that China’s exporters are stealing a march on its own manufacturers and demands that the Chinese revalue the yuan to dull their competitive edge. Mr Snow will repeat this call next week, urging the Chinese to introduce more “flexibility” in their exchange-rate arrangements. A truly flexible exchange rate can move either way, of course. Mr Snow only cares that China’s moves up.
China faces a dilemma common to all the dollar creditors in the region, argues Ronald McKinnon of Stanford University. If they let the dollar fall against their currencies, they would suffer a capital loss on their holdings of dollar assets. A cheaper, more competitive dollar is a boon to the American manufacturer, but a bane to the holder of dollar assets. Indeed, the very fear of such a capital loss can bring it about, if it prompts private holders of dollars to flee from the greenback into the domestic currency. In East Asia, emerging markets have almost as much to fear from a run into their currencies as from a run on them.
In China, despite its thicket of capital controls, speculators have already placed bets on a revaluation of the yuan. The authorities have kept a peg of 8.28 to the dollar since 1994. But though the yuan’s value abroad has remained rock-steady, its value at home has slipped. Inflation is now running at 5.3% per annum. In the past, the People’s Bank of China has talked about raising interest rates if inflation crossed the “bearable limit” of 5% (real rates—ie, adjusted for inflation—are now zero). But to do so would invite further speculative flows into the yuan.
Which brings us back to the Fed. As it raises interest rates, American assets will yield better returns. This will encourage holders of these assets to keep them, rather than dumping them in favour of yuan, won or ringgit. Thus, a tighter monetary policy in America will relieve some of the upward pressure on the currencies of East Asia. In the months ahead, the monetary authorities of emerging markets will be watching the Fed as closely as ever. But this time they may not scurry to follow its lead.
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