The focus of global currency movements
has shifted from Washington and the dollar to the relationship between the euro
and East Asian currencies. Two crucial trends have emerged.
The first is Europe's belated recognition
that the relationship of the euro to Asian currencies is as important as its
position vis-à-vis the U.S. dollar. The European Central Bank may have neither
the will nor the means for direct intervention in currency markets, but European
companies have more to lose from the euro's strength against Asian currencies
than against the dollar.
Asian companies, and particularly
Japanese and South Korean ones, compete more directly with their European than
with their American counterparts. Other strong currencies such as the Australian
and Canadian dollars have been commodity-price driven, so the strain of global
currency and trade adjustment has been falling largely on Europe.
Fortunately for Europe, the second trend
is that some in Asia have woken up to fact that a strong currency is not
necessarily a bad thing. Indeed some voices now accept it not just as inevitable
but as positively beneficial for economies long overdependent on export volume.
The leader in this has not been Japan, as
one might hope, but South Korea, where a weak currency was causing a return of
inflation and doing nothing to stimulate feeble consumer demand. To general
surprise, a country long associated with mercantilist trade and currency
policies has seen the light and allowed its currency to rise. In two months the
won has gained 9 percent against the dollar and 4 percent against the yen.
From a European perspective, however,
there is still a long way for Asia to go to share the burden of global
adjustment. Although Asia's current-account surpluses dwarf those of the euro
zone, the won is still 15 percent and the yen 10 percent weaker against the euro
than it was two years ago. Indeed, Europe's current-account surplus has barely
changed as the U.S. deficit has risen dramatically. Asia traded its way out of
the 1997 financial crisis default through devaluation and a surge in exports,
especially to the United States. Now it is time to reverse the process.
The key to further currency movement is
probably China. It is a guessing game whether Beijing will allow the yuan to
rise - which would likely set off another round of rises for the yen, the won
and other Asian currencies - or whether it will wait until market forces and
covert diplomatic pressure have driven the yen and other currencies up another
15 percent or so, at which point the inflationary cost to China of not following
the currencies of its leading import suppliers would be high.
Meanwhile Europeans have reason to
suspect that Asian central banks had been major players in driving up the euro
while resisting appreciation themselves. A crucial but little noticed paradox of
the past two years has been that the strength of the euro has coincided with a
sharp fall in euro-zone foreign reserves. This suggests that Asian central banks
had not just been shifting reserves into euros but had been covertly buying
euro-zone bonds through commercial banks. Meanwhile, lower euro reserves limit
Europe's ability to undertake some covert intervention of its own to force up
Whatever has happened in the recent past,
it is crucial that Europe and East Asia establish a currency modus vivendi.
Without it, the global adjustment needed to bring the U.S. deficit down to
sustainable levels will be accompanied by some very nasty trade frictions
between Europe and Asia.