Yuan Swallow Does Not Make Summer
Sydney Morning Herald
Thursday August 13, 1998
There has long been a tendency to overestimate the importance of things Chinese, but it reached new heights in financial markets this week over the possibility that the yuan might be devalued in the wake of the yen's weakness, sending other Asian currencies into new downward spirals and leading to global collapse.
Of course, anything is possible in a world of free capital movements where money is shifted and opinions created by 25-year-old market traders and weather-girl economists.
Their prophecies can be self-fulfilling in the short term and leave lasting economic damage behind them (remember the role of the 80-yen dollar in today's Japanese problems?)
The weak yen is going to keep downward pressure on goods prices in North America and Europe and undermine the rosy assumptions built into stock prices on Wall Street and throughout Europe. But the picture in Asia is very different.
First, take the Chinese yuan. Even assuming it is eventually devalued - and almost no-one thinks that likely before next year - its trade impact on the rest of Asia would be modest and slow acting, in the same way that the South-East Asian, Taiwan and Korean devaluations have had only modest impacts on China's exports.
Overall, China's exports in volume terms are still growing at roughly the same rate as those of its neighbours. Those to the United States and Europe are still booming.
China's export problems, such as they are, have been caused mostly by the collapse of domestic demand elsewhere in Asia, rather than by loss of competitiveness. Devaluation would be a tonic for the profitability of Chinese enterprises burdened with over-capacity, debts and weak domestic demand.
But the external trade impact of, say, a 25 per cent devaluation of the yuan would be limited. The value-added factor of Chinese exports is often low, with many having dollar-based components imported from Taiwan, Korea and so on.
As for the rest of the region, a lot of nonsense is written about their need to export their way out of their difficulties and how this would be made impossible by a Chinese devaluation.
The reality is that trade deficits are not a problem in Asia. Volume exports to countries outside the region are still satisfactory, and almost every country in the region is recording huge trade surpluses because of a collapse in domestic demand. The main export problem is pressure on prices caused by excess capacity due to weak domestic demand.
Competitiveness is not an issue. Asia now has it in spades, and from a trade perspective should not be unduly upset by a devaluation of the unconvertible yuan. The only exception is Hong Kong, which has painted itself into a dollar-peg corner which would be unsustainable should China devalue.
The bigger danger is a prolonged weakness in China's domestic demand, causing increased dumping of excess inventory onto world markets.
The problems in Asia outside Japan are not of current account and trade. They are high real interest rates, volatile capital flows and the collapse of domestic demand which followed. What matters far more to them than exchange rates are interest rates and revival of demand at home and among their neighbours.
What matters in particular is a revival of demand and an end to deflation in Japan. If a weak yen helps, that would be good for the rest of Asia. Of Asian exporters, only Taiwan and Korea compete significantly with Japan. For the rest, a weak yen generally improves their terms of trade as Japan is their main source of imports.
But such facts cannot compete with market hysteria. The instant views of the nervous traders in the capital markets can create flows of funds vastly in excess of those mobilised in the short term by the forces of trade and competitiveness.
It is an indictment of open capital markets that scare stories about a yuan devaluation can cause much more economic damage than the reality. The cost of capital has risen, badly needed interest rate cuts are being deferred and recession threatens to become depression.
In the past few days billions of dollars have left Asia because of self-feeding fears based on ignorance of the facts and lack of accountability. That, not the yuan, is cause to worry.
© 1998 Sydney Morning Herald