The Japanese yen and the Chinese yuan are as different as chalk and cheese. The yen is free to float and the yuan is tightly controlled. But as the dollar strengthens in Asia due to the tightening policy of the US Federal Reserve, the central banks in Tokyo and Beijing are on the same course to keep their monetary policies loose.
For very different macroeconomic reasons, the Bank of Japan and the People’s Bank of China have loosened the reins and seem content to see their currencies weaken significantly against the dollar. But the lax monetary policies of the region’s two biggest economies will be a concern for the rest of Asia, which is raising interest rates due to capital outflows and the rise of the dollar. A weakening yuan, in particular, has the potential to dampen the export competitiveness of rivals, potentially triggering a wave of competitive devaluations.
The Japanese yen is, of course, the poster child for monetary profligacy. Since 2013, the Bank of Japan, under the watch of Governor Haruhiko Kuroda, has tried valiantly to arrest a long decline in consumer prices by flooding the financial system with an estimated $5 trillion in easy money, more than the country’s GDP. . The proximate objective of this easy policy was to influence consumer and corporate behaviour, tied to two decades of deflation and pushing inflation above the BoJ’s 2% baseline range.
“It is desirable that inflation reaches our 2% target in a stable manner accompanied by wage increases,” Kuroda said on October 24. At the same time, the BoJ is watching closely as the yen falls to the historic low of 150 per dollar and it is desirable. confusing markets by intervening in foreign exchange markets to arrest the slide.
South Korea and Taiwan, two of Japan’s neighbors, are being heavily influenced by the BoJ’s bold experiments in influencing price behavior. This is because the troika produces and exports high-end electronics and automobiles, so a weak yen provides a significant price advantage for Japanese manufacturers. The Korean won, to be sure, has also weakened against the dollar this year (an estimated 15% compared to the yen’s 20% decline). The risk to regional economic stability stems from the Bank of Korea adopting the doctrine of a weaker winner, under pressure from Korean exporters.
These risks are magnified when China and a weak yuan enter the conversation. Although Japan is deeply integrated into Asian manufacturing, the supply chains tend to be bilateral. Southeast Asian manufacturers do not tend to compete with Japanese firms in the world market. But this is not the case with China, which is deeply embedded in regional supply chains as the final assembly point for products destined for global markets.
Many of the components are sourced from the region and China is also a competitor with the rest of Asia for other products and services. Although the yuan’s weakness is more measured compared to the yen’s fall, it could destabilize regional stability if the PBOC allows the currency to depreciate further.
China’s policymakers are worried about a shrinking economy, with GDP growth expected to be just 3.2% this year, a multi-year historic low. Slowing growth can be largely attributed to the easing of Covid restrictions, but with President Xi Jinping already serving a third term in office, Chinese officials may be tempted to loosen conditions further.
In previous destabilizing economic events, 1998 and 2008 come to mind, China has been projected as a regional leader without depreciating the renminbi. The rest of Asia will be hoping that the PBOC’s magnanimity remains in place. However, there is no regional forum where Asian central bankers can sit across the table and discuss the cross-border implications of monetary policy. Central bankers will say that such forums exist, at least in theory, but difficult topics are rarely raised.
To be fair to the PBOC and the BoJ, the Federal Reserve does not see the global implications of its policies, which are already having a negative impact on emerging markets around the world. In the case of Asia, the impact of the second round of US monetary policy is being felt through lax policies in two systemically important countries. China and Japan should demonstrate regional leadership by arresting the decline of their currencies and promoting regional economic stability. If they fail, a regional currency war will almost certainly result.