No Bang from this Buck

Asia could be heading for trouble again. And it's for an all too familiar reason: currency gyrations. Lacking in solid support from internal demand—especially private consumption—Asia has long been overly dependent on exports as its main driver of economic growth. As such, it is highly sensitive to swings in currency markets, which ultimately define the terms on which Asia exchanges its goods with the rest of the world.

Most of Asia is now facing currency headwinds. That's because the region continues to tie its fate to the U.S. dollar. After nearly three years of declines from early 2002 to late 2004, the greenback rebounded in 2005. Many of Asia's dollar-linked currencies have followed suit—especially those of China, Korea, Thailand, Malaysia, Singapore and India. The Japanese yen has been a striking exception, having weakened 14% against the dollar since early 2005.

A continuation of this trend could pose a serious problem for Asia. The region needs super-competitive currencies in order to keep its export-led growth model humming. To the extent the surprisingly robust dollar drags Asian currencies along for the ride, Asia's exports will become more expensive. Without support from internal consumption, further dollar strengthening could turn the region's export boom into a bust, a devastating development for growth.

China could make or break the Asian export story, because it has become the most important force in pan-regional trade. Its exports rose by 35% to nearly $600 billion in 2004, and are on track to rise by close to another 30% this year. At the same time, China has drawn increasingly on imports from Asian neighbors—especially Taiwan, Korea and Japan—to provide materials and components for its booming export business.

But trouble could be brewing for China. While Beijing technically changed its foreign-exchange mechanism on July 21, it has been reluctant to cut the renminbi (a.k.a. the yuan) loose. After an initial 2% adjustment against the dollar, the yuan has traded within a very tight range over the subsequent four months. As the dollar has gone up, so has the Chinese currency. So far this year, the yuan has appreciated nearly 20% against both the euro and the Japanese yen. Consequently, while the U.S. continues to urge Beijing to allow its currency to strengthen versus the dollar, the yuan has already strengthened against most other currencies. Why should China bow to the U.S. and compound the already serious currency risks bearing down on its exporters?

Fortunately, for most of Asia, there is good reason to believe that currency headwinds might abate. That's because the dollar may be about to resume its multi-year slide. America is suffering from its largest current-account deficit in history—currently running at 6.4% of U.S. GDP and probably headed into the 7.5% range by the end of 2006. History and economic theory point to a resumption of dollar weakening if the U.S. is ever to turn the corner on its current-account problem.

An orderly dollar decline would make Asia's exports cheaper in global markets, but there's an important caveat. Recently, Asia has been drawing support from the long-awaited recovery of the Japanese economy, the world's second-largest. If Japan's newfound vigor is real, there is no overriding reason why the yen should continue to sag. Just as the day will come when the dollar will fall again, a concomitant rebound in the yen is equally likely. That could prove quite vexing to Japanese exporters.

Even if Asia avoids the pitfalls of a further strengthening of the dollar, it still faces two big risks: a long overdue belt-tightening by the American consumer, the region's biggest customer, and protectionism. Either outcome would spell tough times ahead for China and a China-centric Asian economy.

The world's policy makers need to take these risks far more seriously. Washington needs to be more attentive to the root causes of America's massive current-account deficit: an unprecedented shortfall of domestic saving brought on by open-ended budget deficits and a lack of personal saving. A protectionist remedy for America's homegrown problems would be a policy blunder of monumental proportions—taking the world down a very slippery and dangerous slope.

Asia, for its part, must accept greater responsibility for its economic destiny. Time and again, currency fluctuations have proved to be one of the biggest detriments to the region's export-led growth. The only way out is for Asia to become less dependent upon exports, by pressing on with measures to boost internal private consumption. Currency manipulation—whether it's by the Japanese, the Chinese, or other quasi-pegged Asian economies—is no panacea for unbalanced growth.

1. Are Evangelicals Really Sold on Palin?
2. Could Florida Survive the Big One?
3. Collider Triggers End-of-World Fears
4. An E-Mail Plea: Help Pay My Tuititon!
5. Searching for Palin's 'Hot Photos'
6. Mayor Palin: A Rough Record
7. How Sarah Palin Mastered Politics
8. Obama Meets O'Reilly: No One Dies!
9. The Man Behind Palin's Speech
10. Behind Obama's Palin Strategy