April 18, 2010
Imbalances in global economy present dangers
In 1997, the collapse of Asian currencies triggered a policy response in the U.S. that a decade later contributed to the near-meltdown of the world financial system and the worst recession since the 1930s.
But now, nineteen months after the Lehman bankruptcy and more than a year after the equity markets correctly sniffed out a surprisingly robust economic recovery, incremental changes in a dangerously imbalanced global economy seem near - even if the improvements are unfolding at a glacial pace.
Ironically, some of the rebalancing involves reversing declines in those same Asian currencies that spooked the Federal Reserve into assuming its easy money stance in the late 1990s. Setting U.S. interest rates far below nominal economic growth for a prolonged period played a role in inflating destructive bubbles in stock and house prices.
Currencies function as the tectonic plates of the world financial system. Their grinding and abrupt slippage rearranges the global economic landscape.
Which brings up the next "big thing" on the currency front - the long overdue appreciation of the Chinese yuan.
Over the three years prior to the world financial crisis, China had been allowing its currency to inch higher. That changed when Lehman went bust, because Chinese authorities fretted about demand for their country's products in badly weakened world markets.
Since then, China has pegged its currency to the U.S. dollar despite economic growth rates that are not in the same universe.
Estimates of the yuan's undervaluation vary, but if the currency were allowed to float freely in world markets, it would probably rise between 10% and 40% within a few months.
The Obama administration was right to delay a report, originally scheduled for release last week, that would have labeled China a currency manipulator. Though such branding would have been politically popular - and accurate - the best way to get the Chinese to do nothing is to tell them to do something.
Tricky business
Revaluing the yuan is not without complications. Allowing the currency to resume its slow upward creep invites speculative capital inflows, while a major one-time move could shock the world economy.
Yet barring a double-dip recession - a development that would retard Asian exports and give the region's policy-makers a rationale for maintaining the status quo - a rise in the yuan and most other Asian currencies is inevitable. Over the next five or 10 years, the increases could be sizable.
Singapore made the first move toward realignment last week when it allowed its currency to appreciate after more than a year of interventions intended to artificially depress the Singapore dollar.
So how can investors profit from revalued Asian currencies?
Exchange-traded mutual funds are one possibility. But ETFs that hold a basket of emerging Asian currencies are rare and somewhat illiquid. Owning the yen through an ETF is more efficient, but Japanese authorities are keen on pushing their currency lower, not higher.
Commodities seem like a better bet.
Assuming that stronger Asian currencies don't represent the beginning of a major tightening cycle in the region, their increased purchasing power could push commodity prices up, especially given that Asia already is growing briskly.
Large-cap U.S. stocks also could benefit in a relative sense, since corporate behemoths sell a greater share of their goods overseas.
Longer-term, however, the global economy itself will be the biggest winner.
Asian currencies trading at fair value would rebalance growth rates as well as spending and savings patterns, thus mitigating the underlying conditions that promote bubbles. It also could head-off a looming boom-bust cycle in Asia as central banks fought the inevitable inflation with higher interest rates.
A modest economic recovery is taking root in many parts of the world. There is no longer any reason - political or economic - for delay. It's time for China to do what needs to be done.
We'll pretend we didn't even notice.
Tom Saler
http://www.jsonline.com/business/91432854.html
