On the way out the door, the tough-on-Asia Donald Trump administration finally netted a cagey and elusive rival: Vietnam.
After four years of rage tweeting about an “undervalued” Chinese yuan that’s “killing us,” Trump’s Treasury Department opted to put the Vietnamese dong on its dreaded currency manipulators list instead. Xi Jinping’s China got a last-minute reprieve in a new US Treasury report.
No one knows what’s in Treasury Secretary Steven Mnuchin’s head. One possibility: with the dollar down 6.5% versus the yuan this year and the Federal Reserve stimulating like crazy, China could simply – and credibly – retort that it’s Trump who’s trying to devalue his way to recovery.
Though Switzerland, oddly, joined Vietnam formally as a manipulator, Washington’s sense of where the biggest challenges lie is clearly Asia. In addition to the Treasury’s currency manipulator’s list, countries on its longer watch list include China, India, Japan, South Korea, Taiwan and Thailand.
The landscape Biden inherits from Trump on January 20, though, will not be a binary one. It will not just be a matter of dollar-yuan or dollar-yen, but a multilayered and multi-tiered intraregional foreign exchange brawl in Asia – and a broader one with the West.
Look at what’s afoot in the waning days of 2020. The yuan and yen are rising, putting both export-reliant economies, Asia’s two largest, at risk in 2021.
Elsewhere in Northeast Asia, the won is weakening, a move traders claim points to continued currency intervention by the Bank of Korea. In Southeast Asia, meantime, the slide in the Indonesia rupiah also seems central bank-driven.
Gains in the yuan and yen make sense when you consider the relative stability of the Chinese and Japanese economies compared to the West. Indeed, capital is flowing into the region as portfolio managers looking at the hot political messes in Washington, Brussels and London – and fresh waves of Covid-19 infections – bet instead on East Asia.
This, however, might soon prove problematic as recent green shoots get trampled by a returning gloom about the trajectory of global growth. China and Japan can only stimulate domestic demand so much.
“If this currency strength continues, these countries could start to push back harder,” said strategist Manik Narain of UBS. While not ready to say we’re seeing a currency war, Narain said, “you could say there have been some early warning shots.”
Beijing is balancing the need to deleverage its economy and rein in a $13 trillion shadow banking system with supporting growth. Tokyo has already pledged to deploy roughly $3 trillion to soften the blow of its third wave of coronavirus infections. Both governments could use some FX-market relief, and soon.
The odds favor Tokyo joining Seoul in a race to the bottom. If that happens, China would have few choices apart from following suit. Even if you don’t see aggressive unilateral intervention that irks Washington, policymakers may layer on capital controls or investment taxes to tame hot-money flows from abroad.
There’s always the possibility that Asia – recently bound together in trade by the very, very nascent RCEP trade pact – might cooperate and converge instead.
In late November, optimism about Covid-19 vaccines was sending waves of capital into emerging markets. In that month alone, punters gorged on a record $40 billion of emerging market stocks and $37 billion on bonds, according to the Institute of International Finance (IIF). That’s more than the previous three months combined.
“We are recording the strongest pace of non-resident portfolio flows to EM in many years,” noted economist Robin Brooks at IIF. “Factoring in robust offshore bond issuances, Q4 is the strongest quarter since Q1 2012.”
These robust capital inflows, combined with the arrival of vaccines in the first half of 2021, could indeed take down the collective temperature and give Beijing, Tokyo, Seoul and even Jakarta greater confidence to embrace higher exchange rates.
But current trends – such as the divergence between the yen and the won – argue against a convergence toward strong currencies. History also argues against it. As Asia Times has explored, the region’s mercantilist imperative these last 20 years can hold back development.
The crutch of lower currencies is corporate welfare on a vast scale, leaving CEOs less incentive to innovate, restructure and raise productivity. It takes the onus off governments to build economic muscle via supply-side reforms.
Yet Covid-19’s devastation is going to set the region back years in terms of per capita income growth. That’s another reason why the odds favor governments reverting to the beggar-thy-neighbor policies of the last two decades.
China and Japan re-entering the fray will have Korean authorities going even bigger with efforts to weaken the won.
At the end of September, the BOK revealed that it had sold a net $3.8 billion in the first six months of the year as part of so-called “smoothing operations.” The won’s trajectory since then – it’s down 5.5% versus the dollar this year – suggests the BOK may be quietly accelerating sales.
The same might be so of President Joko Widodo’s team in Jakarta and Prime Minister Nguyen Xuan Phuc’s government in Hanoi. This policy convergence toward lower exchange rates would mean that Trump’s trade brawl with Asia mutates into an East versus West race-to-the-bottom currency conflict.
The irony is that this is precisely what Trump wanted in 2016 when he was running for president.
Dating back to the 1980s, then-New York real estate mogul Trump often railed against Asians using undervalued currencies to steal American jobs.
At the time, Japan was cast in the boogeyman role Trump now accords China. In one late ‘80s television appearance, Trump said Tokyo’s policies had “systematically sucked the blood out of America” and “gotten away with murder.”
This is language Xi’s government knows all too well. It also explains why Trump’s trade war with China flopped.
When he finally got his chance to take on Xi’s Communist Party in 2017, Trump employed tactics from 1985. That was the year the largest industrialized economies engineered a huge upward revaluation of the yen. That accord was forged at New York’s Plaza Hotel, an institution Trump owned for a time in the ‘80s.
This stuck-in-the-past worldview explains why Xi ended up owning Trump. Gone are the days the Group of Seven (G7) nations can snap fingers and will their way to epochal trade-relationship changes. Nor do such policies in the 2017-2021 context make the US more innovative, productive or ready to maintain its advantages in a global economy changing at warp speed.
Even so, President-elect Joe Biden might be loath to see the dollar jump higher as 2021 unfolds. He inherits a pandemic-ravaged economy that lost millions of jobs, a national debt racing past the $27 trillion mark and a central bank that swelled its balance sheet to more than $5 trillion.
As the Biden administration looks for ways to juice growth, a weaker dollar will be a tempting shock absorber.
“Perhaps the greatest clarity post-election is for global trade,” wrote Citi Private Bank strategists David Bailin and Steven Wieting. “US foreign policy will enter a more predictable phase without escalating tariff threats. We see a declining US dollar, and rising emerging markets as highly likely.”
America’s poor fundamentals may do that for Biden anyway.
As Fitch Solutions argues in a new report, the dollar may be stronger than underlying conditions warrant. “Several factors will weigh on the USD, including loose monetary and fiscal policy in the US, an improvement in global risk appetite, overvaluation of the greenback and falling US real yields,” Fitch argues.
Yet choppy world markets could propel the dollar upward at moments when investors revert to a “risk-off” crouch. “Although we expect the USD to remain in a downtrend,” Fitch argues, “it will be prone to moments of strength as periods of risk aversion lead to a surge in USD demand. And any downside risks to the euro could also lend upside support to the greenback.”
The IIF’s Brooks agrees the dollar has room to fall. In a November 19 report, Brooks concluded “the dollar is substantially overvalued against emerging markets.” In a more recent study, dated December 3, Brooks explored what the IIF sees as the “beneficial effects from currency devaluations, which, when they are large, help rebalance current accounts materially.”
Yet the political fallout from an East-West currency tug of war could make 2021 a volatile and tense year for markets. Already, there’s firm pushback against Mnuchin’s rogue-currency designations.
“Switzerland does not engage in any form of currency manipulation,” Swiss National Bank officials sniffed immediately after the news dropped. At the same time, the SNB stressed it will continue capping the strong franc as deflationary forces intensify.
The State Bank of Vietnam, meantime, said “exchange rate management in recent years is within its general framework of monetary policy and aims to achieve the consistent goal of controlling inflation, stabilizing the macroeconomy.” As such, SBV argues, Hanoi is not engineering an unfair competitive advantage for the nation.
One could argue that a wiser and gentler White House is on the way to reduce temperatures in FX circles.
Biden’s Treasury secretary pick, Janet Yellen, has argued that exchange rate dynamics are far more complicated than Trump’s 1980s worldview implies. Last year, the former Fed chair remarked that “it’s really difficult and treacherous to define when a country is gaming its currency to gain trade advantages.”
Asia, after all, could indeed paint Trump as a FX manipulator. Petty, too. It’s well known that Trump’s tariffs didn’t prompt multinational companies to move Chinese jobs to the US, but rather to Vietnam.
As Harvard University’s Jason Furman puts it: “The Treasury designating Vietnam a currency manipulator is the epitome of everything that is wrong with the entire concept.” The dong, Furman notes, tends to rise and fall with the dollar because of supply and demand dynamics. So, labeling Hanoi thusly betrays a misunderstanding of how markets work.
Vietnam’s government said Thursday it will ensure a “harmonious and fair” trade relationship with the globe’s biggest economy. Yet this last gasp of the Trump era might force Biden “into positions that he will have to get out of somehow,” notes strategist Per Hammered of SEB Group.
That includes tending to bruise feelings in Tokyo. As Mnuchin’s report notes, Asia’s No. 2 economy hasn’t intervened unilaterally in currency markets since 2011. Even so, Tokyo’s current account surplus of 3.1% gross domestic product (GDP) over the four quarters ending in June 2020, which the US views as “sizable,” and a bilateral goods trade surplus of $57 billion with the US, put Prime Minister Yoshihide Suga’s government in Trumpian harm’s way.
Mnuchin’s team allows that the People’s Bank of China refrained from foreign exchange intervention. It did, however, raise objections to state-owned banks appearing to buy foreign exchange assets on a net basis over 12 months through June 2020.
“While intervention proxies do not provide definitive evidence that the PBOC intervened in foreign exchange markets over the review period, this issue warrants further investigation,” the US Treasury said.
India is also likely to test American patience on exchange rates. Few major developing nations face Prime Minister Narendra Modi’s balancing act in 2021 as a torrent of capital rushes Mumbai’s way. Yet the rupee is down roughly 3% against the greenback this year.
The reason: for much of 2020, the Reserve Bank of India kept a tight leash on as global punters plowed around $50 billion into India in shares and stake buys in local companies.
The RBI’s policies are drawing Washington’s attention. The softer rupee might help support exports, but it could lead to headaches – including making it onto the Biden Treasury Department’s manipulators list. With foreign inflows into Indians equities up more than $20 billion this year, the most since 2012, the RBI’s ability to cap the rupee might be limited.
Indonesia, meanwhile, is an example of how the Fed’s ultra-loose policies may give Asian peers more room to ease – perhaps in ways that exacerbate currency tensions. Bank Indonesia, for example, is experimenting with highly controversial “debt monetization” policies.
BI is buying government bonds directly from the Ministry of Finance to turbocharge easing efforts. This policy and others could accelerate the rupiah’s 1.9% drop versus the dollar this year – and draw Jakarta even more attention from the West should Southeast Asian neighbors follow suit.
So here are the risks. Before Team Biden knows it, it has on its hands currency squabbles within and between Northeast Asia and Southeast Asia, and a broader cross-Pacific currency war. So much for hopes for a quieter 12 months ahead.