Asia's economic generals are fighting the wrong war
with Tom Holland
Army generals, it is said, always prepare to fight the last war. For example, when the British army's expeditionary force crossed the English Channel at the beginning of the first world war, its order of battle included no fewer than 15 regiments of cavalry.
Having learned the lessons of earlier conflicts, Britain's generals boasted that they had assembled the finest cavalry force ever seen and dispatched it to Flanders, confident that it would sweep all its enemies before it.
Happily for the horses, someone soon realised that in an age of industrialised warfare, ordering mounted cavalry to charge against emplaced machine guns would be a recipe for disaster, and the cavalry went into action dismounted.
But as with military generals, so it seems with central banks and finance ministries.
Yesterday, Hong Kong got together with East Asia's three economic giants and the 10-member Association of Southeast Asian Nations to sign an agreement setting up a US$120 billion foreign exchange fund to defend the region against possible future currency crashes.
From next year, any of the 13 signatory countries running short of foreign reserves because of a balance of payments crisis will be able to borrow US dollars from the fund to beat off any speculative attack.
According to the official release, the new fund, which will bear the unbelievably clunky name of the Chiang Mai Initiative Multilateralisation (CMIM), 'will strengthen the region's capacity to safeguard against increased risks and challenges in the global economy'.
Retentive readers might be forgiven for wondering what exactly is so new about yesterday's statement. After all, the establishment of the CMIM was confirmed in May, having been agreed in February nearly two years after it was announced and over five years after it was proposed as a refinement of a facility dating to 2000. That facility, the Chiang Mai Initiative, grew out of a pre-existing currency swap agreement between Asian central banks dating back to 1977.
Clearly, the details have taken a long time to negotiate. And that's the problem. The negotiations have now been so lengthy that the new facility already looks long outdated.
The CMIM was intended to defend the region against any repeat of 1997, when a speculative attack against Thailand, which found itself dangerously short of foreign reserves, spread by contagion to the rest of the region.
But the world has changed over the past 12 years. For the most part, East Asian countries have adopted more flexible currency policies, which means they are no longer obliged to defend untenable fixed exchange rate regimes. And over the intervening years, they have accumulated more than US$3 trillion of foreign reserves between them, which means the risk of any 1997-style regionwide speculative assault is infinitesimal.
Today, the problem is not that emerging Asia's currencies are overvalued and vulnerable to attack. It's the opposite: most are undervalued against the currencies of developed-world countries, raising the risk of destabilising internal asset bubbles and heightened domestic inflation.
Countries in the region could counter those risks, and increase the purchasing power of their consumers, by allowing their currencies to strengthen. But no one wants to be the first to move. Each is afraid that unilateral appreciation will disadvantage its exporters compared with those of its neighbours who refuse to allow their own currencies to rise. The result is a Mexican stand-off that could damage the entire region.
What is required today is not a multilateral fund to defend the region's currencies against speculative attack. That's already obsolete.
What's needed is an agreement among East Asian countries to allow a co-ordinated appreciation of regional currencies against those of the developed world. That would help avert the dangers of inflation and go a long way towards rebalancing the global economy, while minimising the threat of a disruptive adjustment.
Unfortunately, instead of training for the next war, our economic generals are still marshalling their cavalry in preparation for the last. Charge!