Big Mac Index , Mercantilist Fallacies and ASEAN Currencies

An updated graph of the Big Mac Index is shown by The Economist.

THE Big Mac index, says the Economist, is based on the theory of purchasing-power parity (PPP), according to which exchange rates should adjust to equalise the price of a basket of goods and services around the world.

Again, the above shows that ASEAN and other Asian countries as having the most affordable ‘Big Mac’, while the euro area remains the most expensive.

If we go by the mercantilist perspective where cheap currencies=strong exports then we must deduce that outside China, South East Asia should be today the world’s biggest exporters.

Well unfortunately, again with the exception of China, this isn’t true. The priciest currency, the Euro, according to the table from the CIA, lodges the largest exporting region of the world.

Why is this so?

Because currency values do not solely determine exports or wealth for that matter. There are many factors involved and chief among them are the nation’s capital, production and the market structure, and importantly the desire to compete...

And as part of capital structure, this includes the perception of stability, which as example, the Economist cites the Swiss Franc,

``Investors looking for a safe place to put their money have sought refuge in the Swiss franc. Despite attempts by the Swiss central bank to stem the appreciation, the Swiss franc is overvalued by 68%”

This means that if the intent or priority is to seek a safehaven, then pricing risk from a ‘stable’ currency becomes less sensitive relative to other forms of risks.

Nevertheless, the affordability of ASEAN’s Big Mac in itself doesn’t intuitively posit that her currencies would close or equalize the gap with that of the Euro.

Instead ASEAN’s intent to expand trade with the world (globalization) and undergo more economic integration with the region (regionalization) should be the primary reason why the ASEAN’s currencies should be a buy.

The other way to say it is that the convergence won’t come from currency values, in as much as from lower costs (wages etc.), but from increasing wealth from free trade which would then be reflected on the respective currency.

Of course, the only way to devalue a currency is to print more of it, which essentially gives justification to expand government at the expense of the market or a euphemism for socialism.

Asian Regional Integration Deepens With The Advent Of China ASEAN Free Trade Zone

Finally, the dream for an Asian regional integration has finally got the ball rolling.

This from the AFP/Google, (all bold highlights mine)

``China and Southeast Asia establish the world's biggest free trade area (FTA) on Friday, liberalising billions of dollars in goods and investments covering a market of 1.7 billion consumers.

`Eight years in the making, the ASEAN-China FTA will rival the European Union and the North American Free Trade Area in terms of value and surpass those markets in terms of population.

``Officials hope it will expand Asia's trade reach while boosting intra-regional trade that has already been expanding at 20 percent a year....

``China has just overtaken the United States to become ASEAN's third largest trading partner, and will leap Japan and the EU to become "number one" within the first few years of the FTA, said Pushpanathan, Deputy Secretary-General for the ASEAN Economic Community.

``Under the agreement, China and the six founding ASEAN countries -- Brunei, Indonesia, Malaysia, Philippines, Singapore and Thailand -- are to eliminate barriers to investment and tariffs on 90 percent of products.

``Later ASEAN members, including Vietnam and Cambodia, have until 2015 to follow suit...

``Average tariffs imposed on Chinese goods by ASEAN states will fall to 0.6 percent from 12.8 percent.

``ASEAN-China trade has exploded in the past decade, from 39.5 billion dollars in 2000 to 192.5 billion last year, Pushpanathan said.

``At the same time, ASEAN-China trade with the rest of the world has reached 4.3 trillion dollars, or about 13.3 percent of global trade.

Well the trend towards the deepening economic and financial integration has already been in place (see above charts from ADB), in spite of the just concluded pact.

This means that the implementation of the regional trade agreement has been merely a furtherance of an existing trend and that would likely get more entrenched in region's pursuit of freer markets.

Yet, this flies in the face of rabid mercantilists who continue to predict protectionism as imbecilic outcomes (actually desired solutions) in response to today's crisis.

According to ADB's Emerging Asian Regionalism, ``Asia is now broadly as interdependent in trade as the EU and North America each is. Indeed, Asia now trades more with itself than either the EU or North America did at the outset of their integration efforts."

Here are the benefits of the a regional trade integration as enumerated by the ADB:

"An integrated Asia can:

• link the competitive strengths of its diverse economies in order to boost their productivity and sustain the region’s exceptional growth;

• connect the region’s capital markets to enhance financial stability, reduce the cost of capital, and improve opportunities for sharing risks;

• cooperate in setting exchange rate and macroeconomic policies in order to minimize the effects of global and regional shocks and to facilitate the resolution of global imbalances;

• pool the region’s foreign exchange reserves to make more resources available for investment and development;

• exercise leadership in global decision making to sustain the open global trade and financial systems that have supported a half century of unparalleled economic development;

• build connected infrastructure and collaborate on inclusive development to reduce inequalities within and across economies and thus to strengthen support for pro-growth policies; and

• create regional mechanisms to manage cross-border health, safety, and environmental issues better."

While freer trade doesn't necessarily guarantee everyone's success, this should enhance opportunities in trade, investments, financing and migration flows aside from the benefiting consumers via lower prices and a greater array of choices of available products and services in the marketplace.

In short, benefits enjoyed by society would likely be immensely greater than the costs.

In addition, increased competition should bring about greater technological advancements via innovation, expands the division of labor and comparative advantages of producers which allows for more pricing and resource allocation efficiency.

As Austrian economist Hans F. Sennholz wrote, ``Surely, it is no easy task; it requires continuous changes in economic structure and adjustment processes. Labor markets need freedom and flexibility in order to create ever new employment opportunities that offset unavoidable job losses. Workers must have the opportunity and incentive to acquire knowledge and ability needed in a globalized economy. General education and vocational knowledge are becoming ever more important as are entrepreneurship, research, and development. But above all, the economic future of many businesses in a globalized economy greatly depends on the margin of political and social freedom they enjoy."

Nevertheless competition and greater choice translates to lower rates of inflation.

This has seen with the price of gold in the 1990s where the greater degree of global integration has resulted to what has been known as the "great moderation"

As we wrote in Gold: An Unreliable Inflation Hedge?, ``Global Exports sharply accelerated during the 1990s, which underpinned almost the same degree of expansion in Global GDP per capita.

``So increased global trade meant more US dollar financing, as manifested by the burgeoning trade deficits, yet the increased output from the world resulted to higher productivity and thus generally growth deflation or “disinflation”. Ergo, lower gold and commodity prices."

Of course, vested interest groups or economic rent seekers who profited from political privileges are exasperated,

Again the AFP/Google, ``Not everyone is happily singing the free-trade anthem, however.

``At the 11th hour, industry groups in Indonesia, Southeast Asia's biggest economy, and the Philippines are frantically pressing their governments to keep tariffs on vulnerable sectors until 2012."

SO it is yet unclear whether such trade pact will turn out successful because of the vast diversity of culture and political structures which could be sources of pressures or conflicts, aside from the required recalibration and standardization of trade and investment policies, to conform with and enforce on the trade pact.

Finally and importantly, the trade pact reinforces what we see as China's attempt to bolster or flex her geopolitical muscles by advocating that the world's largest free trade zone to utilize her currency, the yuan or the remimbi as the region's medium of settlement or transaction currency.

According to Xinhua, ``Beijing had embarked on the first step on a long road toward making the yuan one of the world's top currencies, allowing Chinese exporters and importers to start settling trade in yuan rather than dollars.

``Wichai [Wichai Kiatrengsuk, vice president of the Bangkok Bank] believes that after the launching of the ASEAN-China FTA in January, how to push forward the RMB-dominated trade settlement would become an immediate issue in this area." [emphasis added]

In short, the FTA appear to be a stepping stone for the yuan or the remimbi's long term path towards the goal to challenge the US dollar hegemony as a major international currency reserve as repeatedly discussed in this blog, such as in Central Bank Policies: Action Speaks Louder Than Words, The Fallacies of US Dollar Carry Bubble.

Bottom line: The fate of the China-ASEAN FTA would likely determine the success of China's tacit plan to become the world's premier geopolitical power. And this likewise could be reflected on her key trading partners.

Stephen Roach: Preparing For The Asian Century

McKinsey Quarterly Interviews Morgan Stanley's Stephen Roach on his latest book "The Next Asia".





Find below the transcript of the Interview from McKinsey Quarterly...(if video doesn't appear pls proceed to McKinsey's website


(all bold highlights mine)

Clay Chandler: We’re joined today by Steve Roach, the chairman of Morgan Stanley Asia. Steve, thank you for being with us. You’ve been watching and writing about the dynamism in this region for many decades now. In your new book, The Next Asia, you write about how the region in the next 20 years will be much different than in the past 20 years. What’s driving that change?

Stephen Roach: Well, Clay, I think the Asia of the past 30 years has done an extraordinary job—especially China, but, increasingly, the rest of the region—in lifting standards of living well beyond anything we’ve seen in the annals of economic development. But the drivers have been primarily export led. And there’s been a lot of investment in the export platform that has been required to get that export machine to the state that it’s at.

But this model is close to having outlived its usefulness. The next Asia will be more consumer led, will have a growth dynamic that places greater emphasis on the quality of the growth experience, especially in terms of environmental protection and pollution control.

Clay Chandler: If I’m the chief executive of a Fortune 500 company and I’m thinking about my global strategy, how do I need to be thinking differently about Asia than I might have been before the crisis?

Stephen Roach: I think global multinationals have, up until now, primarily viewed developing Asia—and China in particular—as an offshore-production platform. The offshore-efficiency solution is still an attractive option. But what really could be powerful would be a growing opportunity to tap the region’s 3.5 billion consumers. This has been the dream all along of the Asian potential. But the consumer dynamic has largely been missing in action. And now, as it comes online, this is an extraordinary bonanza for global multinationals as well.

Clay Chandler: In The Next Asia, you strike a very optimistic tone. You note that Asia has always embraced change and that that’s really been the secret of Asia’s dynamism in years past. But the same thing was said in the wake of the Asian financial crisis in 1997. And yet by and large, most Asian economies went right back to the model that worked so well for them before the Asian financial crisis, a model that was heavily focused on exports and government-led investments. What’s different about the economic scene today?

Stephen Roach: The external demands that underpin the export model are now in trouble. So even if Asia is the best and most efficient producer that anyone has ever seen, the external demand is not going to be there the way it was. So if Asia wants to keep growing, if Asia wants to keep developing, if it wants to keep raising the standard of living for its three-and-a-half-billion consumers, it’s got to depend more on its own internal demand. So it really boils down to the fact that Asia’s options have been narrowed in terms of economic development as never before. And it has no choice but to become more internally, rather than externally, dependent.

Clay Chandler: Let’s talk for a moment, if we could, about India, the other big, growing economy in the region.

Stephen Roach: I think the micro has always been very positive in India: a large population of world-class competitive companies; a well-educated, English-speaking, IT-competent workforce; pretty good market institutions; relatively stable financial institutions; rule of law; democracy. The micro has never been the problem.

What’s really been the problem for India has mainly been the macro—inadequate savings; relatively limited foreign direct investment, especially when compared with China; and, of course, the horrible infrastructure. The macro has actually gotten better. In the last three to four years, India’s savings rates have moved from the low 20s nationwide to the mid-to-high 30s, which is still short of China but a huge improvement for India.

Foreign direct investments accelerated dramatically—again, not up to Chinese standards, but a huge acceleration vis-à-vis where India has been historically.

And the third leg of the stool is politics. The mid-May election, by sweeping the Communist Party out of this new coalition, gives the reformers an opportunity to finally deliver on the promises they made five-and-a-half years ago, when they first took power. I think that India actually could be the real sleeper in Asia over the next few years. Just at a time when everybody is all lathered up and excited over a China-centric region.

Clay Chandler: You can’t really talk about Asia’s future without also considering the trajectory of its largest economy. That, of course, is Japan. The story there has been almost unrelentingly gloomy for years. But now we’ve got a new government.

Stephen Roach: Well, you know, Japan is an example of what happens when you take a very prosperous economy and allow it to experience the post-bubble aftershocks of a massive asset-led implosion.

But here Japan sits, 20 years into the post-bubble era, and it’s not clear that it has really awoken from its long slumber, as you aptly put it. This is an economy that remains very much export dependent. Its two largest export markets, the US and China, are not providing much sustenance. The Japanese consumer is very constrained by demography, by unfunded pension liabilities. It still has a very high predisposition toward saving. There has been some capital-spending impetus in recent years but, again, it has largely been driven by a new export linkage into China, and that’s on hold right now. And then finally, Japan has a horrific leadership problem. So the combination of structural problems, this long post-bubble hangover, leadership issues—it’s hard to be too constructive on the Japanese economy going forward, I’m afraid.

Clay Chandler: How about prospects for greater integration and cooperation in Asia as a whole? In your book, you talk about the emergence of what you call a pan-Asian economic framework. What will that framework look like?

Stephen Roach: Well, I think the building blocks of that framework are starting to fall into place. There’s been increased integration in a China-centric supply chain, with most of the large economies in the region—from Japan, to Korea, to Taiwan—now more dependent on exports to China than any of their other major trading partners, including Europe or the United States. So the logistics of an increasingly China-centric supply chain are starting to fall into place.

But here again, I would say that the real challenge for a pan-regional economic integration would be to shift the structure increasingly away from one that’s externally led to one that’s internally led. When the Asian consumer starts to rise and is sourced increasingly by the Asian producer, that’ll be the real, powerful synergy that I think can take this region to the next place.

Clay Chandler: Is it fair, do you think, to say that the Asian Century has finally arrived?

Stephen Roach: The central premise of my book, The Next Asia, is that it’s a little early to crack out the champagne and declare the onset of the Asian Century. It’s the stuff of great headlines and possibly documentary films, but the next Asia—an Asia which is more balanced, one that brings the Asian consumer into the equation—that’s what the Asian Century needs. The Asian Century, in my view, is not a sustainable image if it’s an Asia of producers or exporters selling things to others. The Asian Century is one where Asia produces to its home markets, rather than just to markets around the world. And until we see that, I think, again, that champagne is going to have to stay on ice for awhile".