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The dangers of a baby step

Philip Bowring

HONG KONG The first log may have been removed from the jam, but there is much work to be done before East Asian currencies are freed from the grip of mercantilism and allowed to rise to levels reflecting the international competitiveness of their economies.
China's ending of its 11-year old peg of 8.28 yuan to the dollar may seem like a victory for U.S. pressure. But unless followed not just by further steps by China but equivalent ones by Taiwan, South Korea, Japan, Malaysia and others, it will do little to right the imbalances in international trade and finance. The first signs have not been encouraging, with these countries appearing to resist even going along with China's modest move.
China had a choice: to go for a significant revaluation - say 15 percent - and then move to a managed float against a basket of currencies, or to end the peg with a baby step while making only a small move toward a meaningful revaluation, merely hinting that more might follow.
It chose the latter, which may be politically most convenient at home. It is small enough to have no impact on trade yet conforms to a promise made more than three years ago to end the peg when the time was ripe. It will presumably buy some time with the U.S. administration and even with a Congress seemingly itching for a confrontation with China.
It is also well timed, coming when the Chinese economy is growing faster than official expectations and after a huge rally in the dollar. Assuming that the dollar rally is short-lived, China will then be able to take further small steps, raising the yuan against the dollar while keeping it steady against the yen, the euro, the won and other currencies.
However, Thursday's small step also carries with it several dangers. The first is that unless it is followed by further steps between now and September, taking the appreciation toward double digits, it will do little to mollify China's critics and avert threatened trade sanctions. The second is that expectation of a series of small steps can only lead to further floods of speculative money into the yuan. That will exacerbate China's excessive monetary growth, which has instigated real estate and fixed investment binges. China's capital controls are insufficiently watertight. Third, it will delay the stimulus to consumption that a higher currency should bring by reducing the costs of inputs like energy and steel, which are far more significant for China than for service-oriented developed economies.
Despite the fact that most East Asian economies are dependent on imported energy, most continue to rack up huge trade and current account surpluses. Tsunami-hit Thailand is the only exception. Despite oil, the current account surpluses of Japan, Korea and Taiwan are likely to be at least 3.5 percent of gross domestic product, probably more than that of China. Meanwhile energy-exporting Malaysia's surplus is now over 15 percent and still rising. Everywhere in the region, governments are complaining about the dampening effect on consumption of higher energy prices, but failing to use currency appreciation to offset it. In practice, exporting continues to be worshipped, consumption to be discouraged.
Often irrational fear of Chinese competition has deterred East Asian countries from allowing their currencies to appreciate. The U.S. is partly to blame too. It has focused its pressure almost entirely on China rather than on those other countries with bigger overall surpluses. China's huge surplus with the United States is largely a consequence of the use of China by Japanese, Taiwan and Korean manufacturers as a base for exporting to America. China has an overall deficit with East and Southeast Asia.
The reaction so far to China's move has been extremely disappointing to those looking for broad and effective Asian realignments. Malaysia has, at last, abandoned its own dollar peg but so far allowed only a minuscule appreciation of the ringgit. The yen took an initial leap but then fell back on fears of official dollar buying and remains 9 percent below its level at the start of the year. The won and Taiwan dollar continue to be manipulated, mostly to track the yen.
American and European focus on China even as the bigger problems lie with other Asian currency values remains an obstacle to the general realignments that the global economy badly needs. China's resistance to change has been strengthened by focus on its surplus to the exclusion of others.
Attention needs to shift toward those others - all open, capitalist and more developed market economies - if China is now to be helped to make quick, if small, steps to a meaningful revaluation. The failure of that to happen will not only threaten trade, it will exacerbate the already worrying level of political tensions between a deeply indebted America and a rising China.
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