The Japanese yen and Chinese yuan are as different as chalk and cheese. The yen is free-floating and the yuan is tightly controlled. However, while the dollar strengthens in Asia due to the US Federal Reserve’s tightening policy, central banks in Tokyo and Beijing are on the same course in keeping their monetary policies loose.
For very different macroeconomic reasons, the Bank of Japan and the People’s Bank of China have loosened the reins and seem pleased to see their currencies weaken significantly against the dollar. However, the loose monetary policies of the region’s two largest economies will be a cause for concern for the rest of Asia, which raises interest rates due to capital outflows and the rising dollar. In particular, a weakening yuan has the ability to blunt competitors’ export competitiveness and potentially trigger a wave of competitive devaluation.
The Japanese yen is, of course, the poster child for monetary waste. Since 2013, the Bank of Japan, under Governor Haruhiko Kuroda, has boldly sought to stem a prolonged decline in consumer prices by flooding the financial system with an estimated $5 trillion in easy money, greater than the nation’s GDP. The immediate goal of this easy policy was to keep pace with two decades of deflation, influencing consumer and corporate behavior and pushing inflation above the BOJ’s core 2% range.
“It is desirable that inflation steadily reach our 2% target, accompanied by wage increases,” Kuroda said on October 24. He confused the markets by intervening in the foreign exchange markets to stop the slide.
Japan’s two close neighbors, South Korea and Taiwan, bear the brunt of the BOJ’s bold experiments in influencing price behavior. This is because Troika produces and exports high-quality electronics and cars, so a weak yen gives Japanese manufacturers a significant price advantage. Of course, the Korean won has also weakened against the dollar this year (an estimated 15%, compared to the yen’s 20% drop. The risk to regional economic stability stems from the Bank of Korea’s adoption of a weaker win doctrine under pressure from Korean exporters.
These risks escalate when China and a weak yuan enter the conversation. While Japan is deeply integrated into Asian production, supply chains tend to be bilateral in nature. Southeast Asian manufacturers do not tend to compete with Japanese firms in the global market. However, this does not apply to China, which is deeply embedded in regional supply chains as the final rallying point for products destined for world markets.
Most components are sourced locally, and China is simultaneously a competitor to the rest of Asia in other products and services. While the yuan’s weakness is more restrained than the yen’s decline, it has the potential to destabilize the region if the PBOC allows the currency to depreciate further.
Chinese policymakers are worried about a slowing economy, while the IMF forecasts GDP growth this year at 3.2%, the lowest in several decades. Slowing growth can mainly be attributed to the stifling Covid restrictions, but with President Xi Jinping already in office for a third term, Chinese officials may be tempted to loosen conditions further.
While the previous destabilizing economic events of 1998 and 2008 came to mind, China had not devalued the renminbi, projecting itself as a regional leader. The rest of Asia will expect the PBOC’s magnanimity to remain in place. However, there is no regional forum where Asian central bankers can sit at the table and discuss the cross-border implications of monetary policy. In theory at least, central bankers will say such forums exist, but difficult topics are rarely raised.
To be fair to the PBOC and the BOJ, the Federal Reserve is not dependent on the global implications of its policies, which are already having a negative impact on emerging markets around the world. In the case of Asia, two systemically important countries are feeling the impact of the runoff effects of US monetary policy through loose policies. China and Japan should show regional leadership and support regional economic stability by stopping the decline in their currencies. If they fail, the result will almost certainly be a regional currency war.