Concerted approach advisable to revalue Asian currencies

Richard Koo (Chief Economist, Nomura Research Institute)

The US trade deficit is reaching a devastating level of 500 billion dollars annually. Faced with such a huge trade imbalance, European countries recognized the necessity to adjust the exchange rates in order to avoid a meltdown of the dollar, and thus allowed the value of the euro to appreciate as much as 50% against the US dollar. Moreover, while the euro was appreciating, European Central Bank did not intervene in the foreign exchange market even once. There was a high-level consensus among officials in Europe that although the revaluation of the euro may have adverse effects on exporters in Europe, it would be necessary to stabilize the global economy.

On the other hand Japan, China, and Taiwan -- among the economies with the largest trade surpluses in the world -- have maintained the policy of sustaining their exchange rate levels with the dollar through huge volumes of interventions. By doing so, they are amplifying rather than correcting trade imbalances. This has prompted strong protest from Europe and the US, who are demanding that the Japanese yen and Chinese yuan be revalued.

The reason European countries could bear 50% appreciation of their currency against the dollar was the euro. The introduction of the euro as a common currency made a large portion of their foreign trades by European countries effectively those of domestic commerce, and traders became less vulnerable to exchange rate fluctuations. If French francs and German marks had remained as in the past, with uncertainties surrounding the direction of neighboring countries' currency, a phenomenon such as a 50% hike of one currency against the dollar would not have been tolerated.

This means that if authorities in Asian countries could take a concerted step to revalue their currencies simultaneously in terms of timing and value, large-scale currency adjustments would be possible without any effect on regional trade within Asia. For example, if a realistic limit is considered to be 100 yen to the dollar for the Japanese companies if only yen were to be revalued, it might become possible to stretch it to 90 yen to the dollar if other Asian currencies would adjust simultaneously.

Asian exporters have not been able to raise their prices on exports to the US because of uncertainties surrounding the responses of other countries competing to sell into the US market. In effect, exporters have shaved their profits to compensate for the burden caused by appreciation of their own currencies. It was US consumers who enjoyed the margin thus created, and this is the reason the trade imbalance of the US against Asia has not been remedied despite depreciation of the US dollar.

If Asian currencies could be revalued simultaneously, the situation where US consumers prosper at the cost of Asian corporations would diminish. It would also make it difficult for the US to easily opt for a lower dollar.

The major uncertainty is whether China would participate in such a scheme. China is currently opening up its market with the aim of increasing imports in order to contain the pressure for the yuan to hike. Although that is the most reasonable approach to avoid currency appreciation, because the volume of imbalance between China and US is so huge, it is probable that even Chinese authorities feel that such a measure would not enable the yuan to remain at current levels for long. If so, the Chinese would want to avoid the situation where their currency alone is to be revalued, which would be a strong motive to join the concerted scheme.

It used to be that Asia was the most unorganized regions in the world, mainly because the two powers in the region, Japan and China, had been hostile toward each other from the 1930s until the end of the cold war. Moreover, China and Taiwan are still in a state of "civil war", while there is no diplomatic relationship between Japan and Taiwan. As a result, Asian countries including Japan were in the habit of communicating with one another through Washington, as exemplified by the recent discussions on nuclear development by North Korea.

However, as the economic developments of Asian countries reach comparable levels, and as each country is confronted with a common issue of trade imbalance with the US, it makes sense for those countries to voluntarily get together and cooperate on an exchange rate adjustment against the dollar. It would benefit everyone, Asia as well as the US, for the respective countries to actively participate in an effort to resolve the issue, rather than each country reacting passively and singly against further depreciation of the dollar.

(The original Japanese article appeared in the May 1-8, 2004 issue of Weekly Toyo Keizai)