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| China and Japan could be on the brink of competitive devaluations. Image: Getty / Screengrab / Al Jazeera |
TOKYO – The significant 10% depreciation of the yen this year has the potential to create uncertainty for global investors, who typically dislike such wildcard situations.
Historically, Asian governments from Seoul to Jakarta have grown accustomed to Tokyo's penchant for mercantilism. Sustaining a weakened yen to bolster exports has been a consistent strategy for Japanese leaders since the 1990s.
The current government under Prime Minister Fumio Kishida appears more than willing to perpetuate this cycle. However, there are valid concerns that Tokyo may be inviting more trouble than ever before.
Notably, this is the first instance in which Tokyo is testing Asia's tolerance for a weakened yen during a period of economic slowdown in China. While Premier Li Qiang's assurances on Tuesday regarding China's target of 5% economic growth were reassuring to investors, there are lingering doubts as the headwinds continue to intensify.
Another contributing factor is the upcoming US election cycle, which is expected to place unprecedented emphasis on Asian trade, amidst intense bickering between Democrats and Republicans. The likelihood of undervalued Chinese or Japanese currencies becoming politicized flashpoints during the US campaign trail is rapidly increasing.
It is worth considering the potential repercussions of Tokyo's beggar-thy-neighbor strategy on South Korea and Southeast Asian economies, which still bear the scars of the late 1990s. During that period, the aggressive interest rate hikes by the US Federal Reserve led to elevated dollar-yen exchange rates, forcing authorities in Bangkok, Jakarta, and Seoul to abandon currency pegs.
Those competitive devaluations ultimately triggered the Asian financial crisis of 1997-98. Since then, governments have strengthened their banking systems, improved transparency, fostered larger and more robust private sectors, and accumulated foreign exchange reserves to better shield their economies from global shocks.
However, the Covid-19 crisis has revealed that Asia remains overly reliant on exports for economic growth. Over the past 18 months, as Asia emerged from the pandemic, global inflation and the Federal Reserve's most assertive tightening since the 1990s have impeded recoveries.
The decline of the yen and its implications for China present a highly complex and complicating factor in the current landscape.
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| PBOC Governor Yi Gang must keep a close eye on the yen. Photo: AFP / Wang Zhao |
At the headquarters of the People's Bank of China (PBOC), Governor Yi Gang has accelerated the pace of interest rate cuts in response to the slowing economy. In 2023, Beijing welcomes any competitive advantage it can gain from exchange rates.
Economist Robert Carnell from ING Bank states, The PBOC would not want to see a one-way movement in the currency. This indicates that they may not be entirely averse to a further controlled depreciation of the Chinese yuan, especially as rate cuts are likely to continue.
However, China's actions must be within reason, as the government has been striving for years to enhance international confidence in the yuan. A volatile exchange rate could jeopardize the progress made thus far, with the yuan already experiencing a decline of nearly 5% this year.
Carnell explains that China is currently deviating from the global trend by implementing rate cuts instead of raising rates, reflecting a lackluster and disappointing reopening following the containment of COVID-19.
This situation adds pressure on Asian governments and foreign exchange managers, including officials from Japan's Ministry of Finance.
Stephen Gallo, global currency strategist at BMO Capital Markets, suggests that physical intervention to support the Japanese yen is increasingly likely. On one hand, a weaker yen exacerbates Japan's inflation challenges, potentially leading to persistent price increases. On the other hand, Tokyo is cautious about upsetting the team led by US Treasury Secretary Janet Yellen.
In a recent report to the US Congress, the Treasury removed Japan from its currency watch list for the first time since 2016. The list includes economies that no trade-dependent country wants to be on. Meanwhile, seven economies, including China, Germany, Malaysia, Singapore, South Korea, Switzerland, and Taiwan, were placed on the Treasury's “monitoring list.”
The decision surprised many observers, who expected Japan to face criticism for its foreign exchange interventions. However, it is speculated that the Biden administration considers Japan a crucial partner in its efforts to “decouple” from China.
During a June 16 press briefing, a senior Treasury official stated that foreign exchange interventions should only be conducted in “very exceptional circumstances” and after consulting with other countries. In contrast, China is being monitored as an“outlier among major economies” due to its lack of transparency.
For Prime Minister Kishida and Japanese Finance Minister Shunichi Suzuki, maintaining this special treatment from the US Treasury is crucial. Suzuki and Bank of Japan Governor Ueda are concerned that the downward pressure on the yen might intensify beyond their control, leading to a self-sustaining trend that becomes challenging to reverse.
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| Bank of Japan Governor Kazuo Ueda is making no sudden movements on QE. Image: Twitter / Screengrab |
The prospect of further tightening moves by the US Federal Reserve does little to alleviate concerns. However, there is positive news as inflation pressures in the United States are showing signs of easing. In May, consumer prices increased by approximately 4% year-on-year, the slowest rate in two years and down from 4.9% in April.
Economist Stephen Juneau from Bank of America finds the trend in US inflation rates to be very encouraging, stating that there should be continued improvement in core consumer prices, which exclude volatile food and energy costs.
Nevertheless, Federal Reserve Chairman Jerome Powell's team is hinting at the possibility of one or two rate hikes in the coming months. This adds to the challenges faced by the Bank of Japan (BOJ) as it strives to stem the yen's decline without disrupting the markets.
Economist Kristina Clifton from Commonwealth Bank of Australia highlights the stark contrast between the dovish stance of the Bank of Japan and other major central banks, suggesting that the yen is poised for further depreciation in the near term. Clifton anticipates that Japanese authorities may resort to verbal intervention in response to the weak yen.
However, the growing disparity in interest rate policies between Tokyo and Washington poses an increasing challenge. Strategist Vassili Serebriakov from UBS explains that the yen is suffering from a significant negative yield gap compared to other G10 currencies. UBS believes that a change in the BOJ's yield curve control policies at the upcoming July 28 meeting is highly likely.
There is a considerable risk that the weak yen could have adverse consequences this time. Traditionally, Japanese authorities preferred a weak yen to stimulate exports and support industrialization. Hence, intervention measures were primarily taken when the yen became too strong.
Nevertheless, the dynamics have changed, according to market strategist Charu Chanana from Saxo Group. Many Japanese companies have shifted their production overseas, meaning that a weaker yen no longer benefits export-oriented firms as much as before. Additionally, Japan relies heavily on importing resources, especially energy, and a very weak yen makes such imports expensive.
Despite these changes, old habits die hard. Bank of Japan Governor Kazuo Ueda has been in his position for only 80 days, and expectations that he would swiftly exit Tokyo's 23-year quantitative easing experiment have been proven wrong.
Economist Richard Katz, publisher of the Japan Economy Watch newsletter, believes that the yen's decline could accelerate. He points to the correlation between Japanese and American 10-year government bond rates, emphasizing that the wider the gap, the weaker the yen becomes.
Earlier in the year, market participants anticipated a narrowing gap as the BOJ raised interest rates while the Fed began cutting them toward the end of the year. However, Katz notes that fewer market participants currently hold such beliefs, leading to decreased demand for the yen and subsequent depreciation.
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| Demand for Japan’s yen is falling. Image: Facebook |
The Bank of Japan (BOJ) continues to remain absent from the scene. Analysts speculate that BOJ Governor Kazuo Ueda might be hesitant following his predecessor's failed attempt to adjust yield levels on December 20. On that day, former BOJ leader Haruhiko Kuroda announced the possibility of 20-year bond rates reaching as high as 0.5%. The yen skyrocketed, causing turmoil in global markets. Since then, the BOJ has been largely silent.
Market nervousness stems from the potential repercussions of any signs of BOJ tightening. Such indications could trigger a massive liquidity drain on the global economy as carry trades, which utilize the Japanese yen as the funding currency, might begin to reverse. Saxo Group's Chanana explains that this is why the market is on edge.
Geopolitical risks also contribute to the prevailing uncertainty. During his speech at the World Economic Forum meeting in Tianjin, Chinese Premier Li expressed concerns about global efforts to "de-risk" supply chains from China, deeming it a threat to global stability. Li refuted the notion, suggesting that certain invisible barriers erected in recent years are leading the world towards fragmentation and confrontation. He firmly opposed the politicization of economic and trade issues.
Premier Li reassured markets that China is well-equipped to manage risks and achieve this year's 5% gross domestic product (GDP) target. He highlighted the implementation of practical and effective measures to expand domestic demand, stimulate market vitality, promote coordinated development, accelerate the green transition, and enhance openness to the outside world.
A weaker yuan at the margin could aid China in approaching the 5% target through an export surge. However, Li and PBOC Governor Yi must ensure that any currency depreciation occurs in an orderly manner. With the MSCI's index of Chinese equities down nearly 20% from its January peak, exacerbating capital flight is the last thing Beijing wants.
The state-run China Securities Journal newspaper argued on Tuesday that national growth will soon stabilize, echoing Premier Li's assertion, as the pro-growth measures implemented in the past month take effect. Nevertheless, the decline of the yen may prompt both Li and Yi's teams to contemplate why China shouldn't maximize its trade advantage by weakening the yuan.
For South Korean President Yoon Suk-yeol, Indonesian President Joko Widodo, and Singapore Prime Minister Lee Hsien Loong, it becomes tempting to join the fray and also consider weakening their respective exchange rates.
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| A mournful Thai holds a Thai baht note. Photo: NurPhoto via AFP Forum / Anusak Laowilas |
The same applies to Philippine President Ferdinand Marcos Jr, Malaysian Prime Minister Anwar Ibrahim, Vietnamese Prime Minister Phạm Minh Chính, or the forthcoming leadership in Thailand.
Even if it's only Japan and China pushing the boundaries of beggar-thy-neighbor policies, politicians in Washington will undoubtedly take notice. As President Biden seeks reelection, Republican contenders, many of whom are eager to scrutinize China regarding the origins of Covid-19 and harbor suspicions towards Asia in general, are bound to accuse Beijing and Tokyo of engaging in unfair currency manipulation.
This is just one of the numerous ways Japan's long-standing fixation on a weak yen could potentially backfire with catastrophic consequences this time around. Nowhere is this more evident than in Beijing, which cannot be pleased with Tokyo's passive indifference.
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