After eight years, finance seems to smell the smoke of Asian currency war.
Let's first look at the exchange rate of the yen. It shows that the exchange rate of the yen against the US dollar has depreciated by 10% since the beginning of 2022. Such a rapid depreciation rate even exceeded the explosion of the Asian financial crisis in 1997. At that time, it was the first rapid depreciation of the yen that opened the prelude to the Asian currency war.
Let's look at the Korean won exchange rate. Since 2022, the US dollar has depreciated by 3.1% against the Korean won. Although it is far less than the depreciation range of the yen in the same period, from the perspective of the sustainability of the depreciation, this round of depreciation of the Korean won has lasted for 15 months since January 2021, and the depreciation range has exceeded the period of Asian currency devaluation tide from 2014 to 2015.
If we look at the current round of devaluation of Asian currencies since 2021, as shown in Figure 3, the devaluation of RMB exchange rate since March has lasted only more than one month, while the devaluation of other major Asian economies has lasted at least one quarter. Therefore, from the perspective of amplitude, it is obvious that the devaluation of RMB exchange rate is dwarfed by the rapid decline last week, However, it is still unable to stop the depreciation of the yen relative to the RMB to a low of nearly 30 years. Taking history as a mirror, the sharp depreciation of the RMB means that the Asian "currency war" has entered the second half. What does this mean for the market? How does the policy deal with the relationship between depreciation and inflation? This is the question that this report attempts to answer.
Historically, the "contagion" of currency devaluation in Asia is very strong. On the one hand, Asian economies have the commonality of "export orientation". On the other hand, the exchange rate is an economic variable of "beggar thy neighbor". In the environment of economic downturn, slow running also means greater pressure, and the yen is often the first to run. Typical periods in history include the Asian financial crisis in 1997, the global financial crisis in 2008 and the turmoil in emerging markets caused by the tightening of the Federal Reserve from 2014 to 2016. We selected the simple resumption from 1997 to 1999 and 2014 to 2016. The biggest difference between these two periods lies in the marketization of RMB and the degree of opening up of China's market to the outside world:
The financial crisis in 1997 led to the decoupling of Asian currencies from the US dollar one after another, and the RMB was fully determined to stabilize the basic market in Asia:
The first stage (19941996) was the alarm of Latin American currency crisis. In order to prevent the economy from overheating, the Federal Reserve started a rapid interest rate hike cycle (250bp interest rate hike in 1994), which eventually led to a vicious circle of "rising cost of external debt - rising pressure of exchange rate depreciation" in Latin American economies. In December 1994, in response to the reduction of monetary reserves and improving the international competitiveness of domestic products, the Mexican government announced that the peso depreciated by 15%. Then the peso was sold off by investors, affected by the spillover effect, The Brazilian real and other currencies also depreciated rapidly, and some Asian currencies were slightly affected. At that time, China's exports grew strongly. Under the influence of capital control and exchange rate formation mechanism, the RMB was not affected, but appreciated after the exchange rate reform in 1994.
In the second stage (19971999), the RMB will not depreciate under the Asian financial crisis. The impact of monetary tightening by the Federal Reserve has not yet subsided, deflation has occurred in Asian countries, commodity prices and commodity currencies have been dragged down, and the yen has been devalued since the first quarter of 1995. In July 1997, the abandonment of the peg of the Thai baht to the US dollar triggered the devaluation of major Asian currencies (except RMB), and the outbreak of the Asian financial crisis: the Thai baht depreciated by nearly 47% within six months after the outbreak of the Asian financial crisis. During the period, except RMB, currencies of all countries depreciated, with an average depreciation of nearly 28.5% during the Asian financial crisis. In response to the Asian financial crisis, China began to implement a proactive fiscal policy. At the same time, it has repeatedly announced that the RMB will not depreciate and tightened the floating range of the RMB against the US dollar. During this period, the nominal effective exchange rate appreciated by 14%, and the RMB appreciated against the currencies of Asian countries.
From 2014 to 2016, the devaluation of Asian currencies showed obvious "two-stage" characteristics, with RMB 811 as the watershed:
In the first stage (20142015), the Fed tightened and the yen ran away. In 2014, the Federal Reserve officially stopped QE. Since the second quarter, Japan's economy unexpectedly fell into negative growth, led by the decline of the yen (with a cumulative decline of more than 10%), and the depreciation of the yen triggered the "currency war" in Asia. In order to avoid the loss of economic competitiveness, the central banks of South Korea, Indonesia and India took lenient measures to promote the devaluation of their currencies. However, in the United States, the economic fundamentals are strong, the market's expectation of the Fed's interest rate hike is rising, the US dollar is stronger, and the RMB effective exchange rate "soft pegged" to the US dollar rises accordingly.
In the second stage (20152016), the depreciation of RMB accelerated (the cumulative depreciation was nearly 8%), and the global market was volatile. On August 11, 2015, the reform of the RMB central parity quotation mechanism led to a one-time devaluation of nearly 2%. Subsequently, the RMB continued to weaken under the slowdown of China's economic growth. The central bank lowered the reserve requirement and interest rate for many times to stabilize the economy. Only after the credit data rebounded in September 2016 did the RMB stabilize. The Malaysian ringgit, which fell significantly in the same period, fell by 7.1% in total. The political turmoil under economic pressure is an important reason. The US dollar continued to strengthen, with a cumulative increase of 3.7%, supported by the expectation of interest rate hikes and the depreciation of Asian currencies.
Taking history as a mirror, from the perspective of exchange rate, China is an important cushion for the downturn of the Asian or global economy. The devaluation of RMB in late April means that the devaluation of Asian currencies has entered the second half, and the global market will face greater turbulence in stages.
The dilemma of China's policy in the short term lies in: on the one hand, the depreciation of RMB exchange rate should be greater, which may stabilize the economy and market; On the other hand, substantial depreciation and high commodity prices will bring imported inflation, and there is uncertainty. Slow depreciation may be more in line with the current policy needs, but it cannot be "slower" than that of major Asian economies such as South Korea and Japan.
The RMB is "aware" in the "currency war", which makes China an important cushion for the economic downturn in Asia. As shown in Figure 6, since the Asian financial crisis in 1997, when the Asian economy or market was impacted, the yen led the decline and other countries followed, but the "response" of the RMB often lagged behind (it often continued to appreciate in the early stage). On the one hand, it played China's role in stabilizing the regional economy, but on the other hand, it also put greater pressure on China's economy and market.
The stock market is very sensitive to this shift in pressure. As shown in Figure 7, the "looting" behavior of the Korean market is very typical. Whenever there is great downward pressure on the economy, the sharp depreciation of the Korean won relative to the RMB can always bring the excess return of the Korean stock market relative to the Chinese stock market. This has happened since the bursting of the foam of the science and technology network, during the financial crisis and from 2014 to 2015.
After the RMB exchange rate reform in 2015, the "currency war" in Asia presents the characteristics of the first and second half, and the market may face greater fluctuations in the early stage of the second half. In the "first half", Japan took the lead, other Asian economies followed devaluation, and the RMB maintained a steady rise. During this period, due to China's backing, the market volatility was still controllable; In the "second half", the RMB began to price and accelerate the depreciation under the pressure of China's economy. Then, the yen may take the lead in stabilizing, and the decline rate of other currencies will slow down. Finally, with the gradual stabilization of China's economy, the Asian currency war will come to an end. In the second half, the release of China's economic and market pressure will significantly increase the volatility and volatility of the global market, such as from August 2015 to early 2016, such as since late April 2022.
In this process, the US dollar index "reaped the benefits of fishing". The US dollar index had obvious upward momentum in the first half and the early second half of the Asian "currency war", but with the stabilization of the yen and the improvement of China's economic expectations, the US dollar index will also peak periodically.
From a policy perspective, "slow" devaluation may be more in line with the current policy requirements, but in order to stabilize the economy and market, it cannot be "slower" than economies such as South Korea and Japan. In order to cope with the high commodity prices and the uncertainty of imported inflation, the slow depreciation of RMB is more in line with the current policy needs. This is reflected in the central bank's reduction of foreign exchange deposit reserve on Monday (April 25, 2022): the reduction shows the concern about the rapid depreciation of the exchange rate, but it is only reduced by 1 percentage point, indicating that the depreciation direction is still tolerable. Based on the above logic, we believe that the policy response to RMB devaluation may be dynamic. The devaluation cannot be too fast, but it cannot be slower than that of major Asian economies such as South Korea and Japan.
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