With the Federal Reserve maintaining high-intensity rate hikes, the currencies of China, Japan, and South Korea, all major Asian economies, have been more or less affected to varying degrees, and are under increasing pressure of depreciation. The exchange rates of the Chinese renminbi (with the offshore exchange rate as a reference), the Japanese yen, and the South Korean won have all depreciated significantly with the appreciation of the US dollar. As the three Asian countries share similar economic structures, most are on the main manufacturing output side. Many believe currency devaluation will be beneficial to exports, which is conducive to long-term economic stability.
Yet, if the situation of the 1997 Asian financial crisis is taken into consideration, the impact of currency devaluation on capital flows and asset values, and the "currency war" brought about by the devaluation of currencies, this may in fact bring about a sharp rise in financial risks in Asia. A few questions arise in this regard. Is a "competitive devaluation" of a currency good for the economy? Will there be another new currency crisis in Asia? Can China survive a new round of "currency war"?
In this sense, the view that the devaluation of the currencies of the three countries to gain a competitive export advantage seems untenable. In addition, in the context of rising global inflation and the Fed hiking interest rates, foreign trade demand will also decline across the board. In the short term, it is difficult for the manufacturing industry in the Asia-Pacific to obtain more export opportunities through currency devaluation. Instead, the economy itself is dragged down by inflationary inputs from devaluation.
The sharp depreciation of the US dollar has hit Japan and South Korea's weak macro economy, and the two governments have to use their foreign exchange reserves to rescue the market. Japan and South Korea have begun to intervene in the market, and the foreign exchange reserves of both countries have decreased by more than US$100 billion in the past two months, reaching about US$106.8 billion. As far as monetary policy is concerned, these two East Asian nations have adopted opposite policies to respond to the Fed's raising interest rates. South Korea has raised interest rates several times, and the policy interest rate (seven-day reverse repurchase) has reached 3%. At the same time, it also has to start purchasing financial assets, hoping to maintain the stability of the capital market. Japan, on the other hand, continues to adhere to easing policies and yield curve control. However, this also has a more serious impact on the Japanese stock market.
That being said, judging from the current situation, in the absence of capital flow constraints, whether a country closely follows the Fed's tightening policy or pursues the opposite easing policy, it cannot avoid the impact of international capital flows. Comparatively speaking, the situation in South Korea is more serious; though it is not exactly ideal in Japan. The abnormal phenomenon of "zero transactions" of Japanese government bonds has repeatedly occurred, indicating the market is not optimistic about Japan's adherence to the yield curve control policy.
In China, the central bank did take some countermeasures one after another, yet now it has not reversed the trend of currency depreciation. Instead, the pace of depreciation has been affected. The more favourable aspect is that China has not liberalised capital controls so that domestic shocks are limited and speculative transactions in the market are restrained. The results of the monetary policies of Japan and South Korea also show that it is feasible for China to "sacrifice" exchange rate stability in order to maintain the autonomy and independence of its domestic monetary policy.
The trend also demonstrates that it is not easy to avoid the common depreciation of currencies in major Asian economies under the dominance of the US dollar. It is hence difficult for the renminbi to maintain an independent situation where both circumstances both within and outside of the country are increasingly complex with a weaker recovery in the country itself. The only favourable situation is that the three countries jointly bear the pressure brought by the dollar's appreciation. This pressure has a greater impact on Japan and South Korea. However, the current situation, the stability of the respective financial systems, the level of external leverage, and the reserves of the external account, have improved significantly compared to during the Asian financial crisis. All three countries have adopted relatively flexible exchange rate policies, so the possibility of a recurrence of a systemic financial crisis is not significant.
Currency fluctuations reflect the stability of the economic fundamentals of the three countries. Researchers at ANBOUND have previously pointed out that the basis for the stability of the renminbi exchange rate is the stability of economic fundamentals. The same is true for Japan and South Korea. Exchange rate fluctuations and economic stability are in fact interacting with each other. In this case, China is still in a relatively favourable position among the three countries by the virtue of its market capacity and capital account constraints. This, as things turn out, is the basic condition for winning the "currency war". Of course, under the circumstances that the economic, trade, and financial fields are closely linked, the occurrence of a "currency crisis" in neighbouring countries is never good news for China. When this happens, the country itself needs to bear more pressure, the exchange rate will fluctuate more, and it will be more difficult to manage the complex situation.
Wei Hongxu is an economist at ANBOUND, a multinational independent think tank based in China and Malaysia, which specialises in public policy research covering geopolitics and international relations, urban and social development, industrial issues, and macroeconomics.
