Currencies: A Reversal of the Asian Currency Crisis by Stephen Jen of Morgan Stanley

A Reversal of the Asian Currency Crisis

Stephen Jen (Milan)

Similarities with the 1997-98 experience

I find striking parallels between current market conditions and sentiment regarding USD/Asia and the experience during the Asian Currency Crisis in 1997-98. Specifically, the market and some US policymakers seem to be calling for a kind of ‘Asian Currency Crisis in Reverse’. I am in no way looking for a ‘crisis’, either in terms of the magnitude of movements in USD/Asia or in terms of the general level of angst. Rather, I simply point out that the down-trade in USD/Asia that many are calling for, in a way, almost fully reverses the Asian Currency Crisis. If China moves to a ‘crawling band’ in the near future, it is likely that there be a wholesale decline in USD/Asia.

My general view on the USD

In my view, the USD index measured against the major currencies is now undervalued. This undervaluation of the USD is particularly stark against the European and commodity currencies. However, against the Asian currencies, the USD is still meaningfully overvalued. This should not be surprising, given the modest movement in the Asian currencies against a falling USD over the past three years.

However, in light of the widening US C/A deficit, particularly the imbalances run against the Asian economies, protectionist pressures will likely build in the US to indirectly force the Asian central banks to ease off on intervention and absorb a greater share of the economic costs of a weaker USD. The longer China remains robust, the harder it will be for Asia to stave off the downward pressures on the USD against their currencies. Bottom line: USD/Asia may want to trade lower because of relatively robust economic fundamentals, contrary to my expectations since May this year.

What has happened since 1997-98?

The market is increasingly looking for a correction in USD/Asia, for reasons including large and burgeoning external surpluses and high and rising official reserves. These are precisely the opposite traits of many Asian countries back in late-1996, early-1997. In many ways, Asia’s position today is a direct result of the Asian Crisis seven years ago.

The maxi-devaluation of the Asian currencies, coupled with the emergence of China as a viable production entity at around the same time, led to an Asia that is, collectively, much more competitive than it was before the Asian Crisis. At the same time, Asia’s official reserve holdings exploded, rising from US$712 billion in June 1997 to US$2.265 trillion now − an increase of some US$1.55 trillion. Thus, the Asian Currency Crisis put Asia in such a competitive position that the market is now under mounting pressure for there to be a ‘reversal’ of the effects of the Crisis.

RMB float could be the trigger for a sell-off in USD/Asia

The prospective dismantlement of the de facto dollar peg could potentially be the trigger for a broad-based move lower in USD/Asia, at least this is likely to be the knee-jerk reaction. Country-specific idiosyncratic factors may not matter much, at least in the period immediately after the RMB de facto peg is dismantled.

What happened during the Asian Crisis is also illustrative of what could happen when the RMB peg is dismantled. Before the onset of the Asian Crisis in 1997, only Thailand and the Philippines had large C/A deficits, relative to the size of the economies. Nevertheless, the run on all the Asian currencies was indiscriminate. It didn’t matter that Singapore, Taiwan, China, and Indonesia had solid external positions, good growth and low inflation, all of these currencies, with the exception of China, were pushed significantly lower by the market.

Valuation matters

However, over the medium term, valuation should matter as well: those currencies that are more misaligned should come under greater pressures.

First, all six Asian currencies (KRW, TWD, SGD, THB, PHP, and MYR) are undervalued against the USD. Second, compared to the median forecasts, KRW, TWD, SGD and THB are about 5% mis-priced, but PHP and MYR are 20-25% undervalued. Thus, from a valuation perspective, a depreciation in the USD against the Asian currencies makes sense, unlike in the cases of EUR, GBP, and AUD.

Fair values and C/A surpluses

Rather than thinking about the fair values per se, i.e., values of USD/Asia that are consistent with a set of fundamental variables, investors may be asking how low USD/Asia will need to trade in order to help narrow the US C/A deficit. If investors remain fixated on this question, most Asian currencies will likely be pushed deep into overvalued positions before investors stop selling USDs. In other words, if the dynamics of EUR/USD are of any guide, the Asian currencies are likely to be pushed beyond their fair values.

Competitors versus partners: status matters

Over the medium term, it should also make a difference whether the country in question is an economic competitor to China or an economic partner with China. If the decline in USD/RMB is large enough (this is a big ‘if’), countries that compete with China should benefit, while those that supply capital goods and raw materials to China may be hurt. There should, thus, be a disparity in the Asian currencies depending on their relationship with China.

Bottom line

The significant pressure on USD/Asia can be traced back to the Asian Crisis, which I believe was the key reason why Asia has been able to run massive trade surpluses and large foreign exchange reserve positions. In many ways, the market is looking for a reversal of the Asian Crisis. A prospective RMB float could very well be the trigger for such a USD/Asia sell-off. In that event, I expect USD/Asia (particularly USD/PHP and even USD/MRY) to move by more than USD/RMB.