Is another Asian currency crisis coming? Keep an eye on China’s yuan

Concerns about an Asian currency war and what it would mean for the world economy have been underpinned by a strong US dollar
Some economies may choose to intervene in currency markets, but the big question is whether China will devalue the yuan or proceed with caution

Anthony Rowley

Published: 4:30pm, 18 May 2024

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Is another Asian currency crisis in the offing? There is a lot of noise around this idea as the region’s key currencies continue to depreciate against the mighty US dollar. But it will hopefully prove to be a storm in the proverbial teacup provided that China and others keep their nerve.

The Japanese yen has been described by some commentators as being in “free fall” but this is exaggeration bordering upon hysteria. The bigger danger is not a collapsing yen but the possibility that an economically beleaguered China could be pushed into a major devaluation of the yuan.

At the root of the problem is the perceived strength of the US dollar, and the impact this has on capital outflows from Japan and other Asian economies into the greenback as yield differentials continue to widen and currency values adjust accordingly. Government bond yield differentials in favour of the United States have hovered near 400 basis points lately, while the yen has continued to weaken.

This has prompted much chatter about the danger of a new Asian financial crisis similar to the one that struck in 1997. This time the impact could be worse, given the huge weight that China and other Asian economies have in the global economy now.

A Bloomberg article published on May 9, for example, was headlined, “Yen’s fragility raises spectre of a new currency war in Asia”, reporting that investors are alarmed at the prospect of competitive devaluations that could trigger such a war.

There is some superficial similarity with 1997 given that capital outflows were triggered both then and now. But 27 years ago, the basic cause was fixed exchange rates in Asia while today rates are flexible and many nations are better equipped to defend them.

Customers gather outside the International Bank of Asia in Hong Kong after closing time on November 10, 1997, amid rumours of a bank run during the 1997 Asian financial crisis. Photo: AP

At the heart of the problem is what Mark Sobel, US chair of the Official Monetary and Financial Institutions Forum (OMFIF), described in a recent commentary as “generalised dollar strength”.

Or as Hung Tran, a non-resident senior fellow of the Atlantic Council, put it, “most of the world’s currencies have been under pressure from the dollar” which has “appreciated by 30 per cent over the past decade”. Tran observed: “Going forward, dollar strength will be checked only when fundamentals change.”

The market seems to believe that the dollar will stay higher for longer but I would challenge this, admittedly more based on gut feeling. Regardless, no one can fault the US for having an apparently strong economy nor reasonably blame investors for flocking to a strong dollar and to high-yielding US Treasury securities.

But a caveat emptor might be in order. Currency markets, like stock markets, could turn faster than expected with disruptive or even crisis-provoking rapidity where the dollar is concerned. Behind dollar strength are interest rate differentials and the US Federal Reserve’s fixation with reducing an inflation rate driven by short-term factors rather than economic fundamentals.

Recent data from the International Monetary Fund shows that the major build-up in US savings occasioned by the Covid-19 monetary and fiscal stimulus is all but exhausted now, which means the consequent US consumption boom is likely to abate soon.

That in turn could dampen output and demand for labour, another Fed fixation, and interest rates would likely need to be lowered as rapidly as when they began to be raised a couple of years ago after the inflation scare appeared.

Above all, the Biden administration will be anxious to keep the music going in the world’s largest economy in the run-up to the US presidential election and lowering interest rates could be key to that, inflation or not. It could be a case of “lower faster” rather than “higher for longer”. Whether this will mean a return to the status quo depends upon how long Asian central banks can keep their cool between now and then.

There has been some apparent official intervention in currency markets, including reportedly by the Bank of Japan, but this is spitting in the wind given the size of dollar transactions in these markets. The likelihood of the US Fed joining dollar-suppressing interventions this side of the presidential election is small.

02:42

Japanese monetary authorities mull intervention options after yen drops to 34-year low

There may be temptation for some Asian economies, such as South Korea and Taiwan, to try more unilateral interventions. What especially rankles is that the yen has depreciated much more rapidly versus the dollar than their own currencies have. The big question, however, is over mainland China and whether it opts for a major yuan devaluation to improve competitiveness versus the Japanese yen and the Korean won.

A devaluation of the yuan could be the trigger that sets off a fusillade of Asian devaluations. But China may opt for caution at a time when it is anxious to keep as many other Asian countries as possible on board with its policies amid trade and investment wars with the US.

Sobel suggested that “China should avoid renminbi depreciation against the dollar. US authorities should acknowledge that the renminbi pressures are in large part driven by dollar strength, keep the focus on China addressing its growth model and overcapacity and push back on any renewed currency tensions.”

My view is that China, sufficiently aware of its responsibilities as an Asian regional and global power, will not precipitate a currency war and will instead opt to wait out current dollar strength. It probably won’t have to wait as long as impatient currency markets believe.

Anthony Rowley is a veteran journalist specialising in Asian economic and financial affairs