Trends that are shaping the future
Asian currency flexibility
Export-oriented Asian economies, such as China are heavily exposed to the trade imbalances between developed and emerging markets. Put simply, they are selling more in international markets than they are buying. Without monetary intervention, their resulting current account surpluses would probably strengthen their currencies, making their exports less competitive and their imports more competitive - thus restoring balance in their international trade flows. However, some countries’ central banks have protected their export industries by selling their national currencies and purchasing foreign currencies, above all the US dollar (USD). In the long term, this tends to cause one of two problems. Either the central banks will ‘print money’ in their domestic currency to purchase foreign currency, which increases the money supply and tends to generate high levels of inflation; or the central banks will ‘sterilize’ their currency interventions by selling newly issued domestic-currency bonds, which soaks up excess money supply, but imposes losses on the central banks since the interest they must pay on the bonds they have issued will generally be much higher than the interest they receive from their holdings of low-yielding foreign bonds such as US Treasuries.
Asia’s export-oriented economies are reducing their exposure to these problems by gradually allowing their currencies to appreciate. But the process is not continuous. China, for example, allowed the Chinese yuan (CNY) to appreciate against the USD from July 2005 until July 2008 and then imposed a fixed exchange rate for two years before allowing further appreciation from June 2010 onwards - although, so far this year, the CNY has depreciated versus the USD.
For investors, key points to monitor include changes in Asian exporters’ current account balances, inflation rates, foreign currency reserves, levels of domestic demand and macroeconomic policies. By trying to anticipate such changes and looking for mispricings in currency markets, investors can seek profits from positions in the currencies of export-oriented countries including Singapore, South Korea, the Philippines and Malaysia, all of which have large current account surpluses.
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