The Japanese yen and the Chinese yuan are as different as chalk and cheese. The yen is free floating and the yuan is tightly controlled. But central banks in Tokyo and Beijing find themselves on a similar path to loosening their monetary policies as the dollar strengthens in Asia due to tighter policy by the US Federal Reserve.
For very different macroeconomic reasons, the Bank of Japan and the People’s Bank of China have loosened the reins and seem content to see their currencies weaken significantly against the dollar. But loose monetary policy in the region’s two largest economies will be a concern for the rest of Asia, which has been raising interest rates due to capital outflows and a rising dollar. A weak yuan, in particular, has the potential to blunt rivals’ export competition, potentially triggering a wave of competitive devaluations.
The Japanese yen is, of course, the poster child for monetary absurdity. Since 2013, the Bank of Japan, led by Governor Haruhiko Kuroda, has emboldened to stave off a long slump in consumer prices by injecting an estimated $5 trillion of easy money into the financial system, larger than the country’s GDP. The intended objective of this easy policy was to influence consumer and corporate behavior, match two decades of inflation, and push inflation above the BoJ’s baseline 2% range.
“Achieving our 2% target steadily along with wage growth is desirable for inflation,” Kuroda said on Oct. 24. At the same time, the BoJ is watching closely as the yen plunges to a historic low of 150 against the dollar and confuses markets by intervening in the foreign exchange market to arrest the slide.
South Korea and Taiwan, two of Japan’s closest neighbors, are bearing the fruits of the BoJ’s bold experiments in influencing price behavior. This is because the Troika manufactures and exports high-end electronics and automobiles, so a weak yen gives Japanese manufacturers a significant price advantage. The Korean won, to be sure, has also weakened against the dollar this year (by roughly 15% compared to the yen’s 20% decline). Risks to regional economic stability under pressure from Korean exporters result from the Bank of Korea’s adoption of a weak win doctrine.
These risks increase when China and a weaker yuan enter the conversation. Although Japan is deeply integrated into Asian manufacturing, supply chains tend to be bilateral in nature. Southeast Asian manufacturers tend not to compete with Japanese firms in global markets. But this is not just the case in China, which is deeply embedded in regional supply chains as the final assembly point for products destined for global markets.
Most of the ingredients are sourced from the region and China competes with the rest of Asia for other goods and services as well. Although the yuan’s weakness is more measured than the yen’s decline, it has the potential to destabilize regional stability if the PBOC allows the currency to depreciate further.
With Chinese policymakers worried about a slowing economy, the IMF projects GDP growth of just 3.2% this year, a historic low in decades. Slower growth can largely be attributed to the stranglehold of Covid restrictions, but with President Xi Jinping already entering a third term in office, Chinese officials may be tempted to relax the situation further.
In previous unstable economic episodes, 1998 and 2008 come to mind, China has presented itself as a regional leader without devaluing the renminbi. The rest of Asia will expect the PBOC to remain accommodative. However, there is no regional forum where Asian central bankers can sit at the table to discuss the cross-border implications of monetary policy. In theory at least, central bankers would say that such a forum exists, but the hard issues are rarely raised.
To be fair to the PBOC and BoJ, the Federal Reserve does not keep track of the global impact of its policies, which are already having a negative impact on emerging markets around the world. As for Asia, it is feeling the effects of the second-round effects of US monetary policy through looser policies in two systemically important countries. China and Japan should demonstrate regional leadership and promote regional economic stability by preventing the collapse of their currencies. If they fail, a regional currency war will almost certainly result.