Surviving the currency war
The currency war is deepening and widening. Governments are in competition to cheapen their currencies to raise export competitiveness and help revive their sagging economies. The Bank of Japan in January joined the central banks of Sweden, Switzerland, Denmark and the European Union to send its base rate to negative territory. In theory, the drastic action is designed to encourage spending by companies and individuals — instead of piling their money in banks — to stimulate the economy and inflation. But the real motive is to artificially devalue the yen to promote exports.
China brought a major upset to the global markets by suddenly devaluing the yuan by 1.9 percent in August last year. Bets on weakening the yuan became higher as the U.S. dollar shot up to 6.6 yuan early this year. The foreign exchange market is often guided by the self-fulfilling prophecy, or realization of investors’ expectations. Investors can profit if they exchange a currency against another on expectations of a sell-off. If the anticipation broadens, investors will all dump their yuan holdings, leading to further depreciation. Billionaire currency traders like George Soros upped investment in trades linked to a weaker yuan. The pressure on the yuan to go down mounts when deals betting on a weaker yuan increase.
China’s foreign exchange reserves sank more than 15 percent last year. The central bank has been digging into its foreign exchange coffers to stabilize the exchange market. Zhou Xiaochuan, governor of the People’s Bank of China, warned the depreciation couldn’t last and authorities toughened regulations to prevent speculative selling in Chinese capital. But Chinese authorities won’t be able to keep up their defense if capital flight continues. They cannot continue with exchange intervention to uphold the government’s ambitious design to make the renminbi a global reserve currency. They could instead decide to condone a weak yuan to help exports if domestic demand does not grow as much as expected to meet the annual growth target of more than 6.5 percent. Experts believe the dollar could go up above 7 yuan.
A currency war is a zero-sum game to reap benefits for a country at the expense of others at a time when external demand remains depressed. Experts warning of dangers in the ongoing war advised coordinated endeavors to prevent competitive currency depreciations. But the finance ministers and central banks of the G-20 meeting in Shanghai in late February brought about little change on the currency front.
The won would inevitably lose ground when Japan, China, and European states all engage in a devaluation campaign. The Financial Times in an editorial last month advised to sell assets in Korea if investors are worried about China, suggesting Korean currency as a proxy for the Chinese yuan. Investors went on a selling spree in Korean stocks and bonds, sending prices of Korean securities and value in the won tumbling.
Incremental weakening in the won aids exports. But if the plunge is too sudden and steep, currency risks widen for Korean companies and investors. When asset prices tumble on capital flight, private consumption and corporate spending could become dampened. Authorities must therefore map out comprehensive and subtle policy actions.
While refraining from excessive intervention, authorities must step in to smooth the situation when the won turns volatile because of speculative forces. If authorities spend too much of the dollar holdings to defend the currency, the country’s foreign exchange reserves could sharply thin and bring about a liquidity crisis. Korea maintains a current-account surplus even as exports are sagging due to poorer imports from prolonged economic slowdown coupled with depressed oil prices. Korea could be accused of manipulation if it outright intervenes in the exchange market. But authorities must keep up oversight in the capital and currency market to fight off a speculative raid.
Korea must get itself out of the heavy fog over its economy. When exports and domestic demand sink, household and corporate debt becomes riskier. Reforms could be delayed and capital flight could accelerate if confidence in economic policy is lost. Authorities must push ahead with a structural reform agenda and demonstrate will and confidence to revive the economy at home and abroad. If authorities cannot use the option of pushing down the interest rate further to stimulate the economy on concerns of household debt and capital flight, they should consider upping fiscal expansion.
The government should strengthen cooperation and dialogue with other countries. It must not sit quietly back even when policies of other countries hurt our economy. In 2010, Korea became the first among the emerging category to host G-20 summit and helped to coordinate macroeconomic policy of developing economies. Korea should join forces with other emerging countries to coordinate mutually beneficial policies on the currency, fiscal and trade front. It also should strengthen and increase a currency swap agreement with countries with global reserve currencies to toughen our safety net against a liquidity crisis.