China’s currency games could annoy its neighbours

By Wei Gu
August 25, 2010

China’s strategy to diversify away from dollars gets ever more complicated. It has been buying more Asian debt to move some of its $2.4 trillion reserves away from the greenback. But this vote of confidence might not be welcome to politicians in Japan and Korea, who already worry about their currencies being too pricy. Given the risk of financial losses or, worse, political friction, sticking to the dollar looks the lesser evil.

Chinese purchases of Asian debt have paid off so far. The yen has risen more than 8 percent this year so far, and 11 percent since the bulk of Chinese buying was done in May and June. The won has appreciated close to 7 percent since its April low. Korean bonds yield more than both U.S. and Chinese bonds. Japanese 10-year bond yields are less than half of what their U.S. counterparts offer, but currency appreciation offers some consolation.

Those purchases may look less clever if currencies depreciate. Two Japanese cabinet ministers on July 20 called for the central bank to tackle the yen, since this year’s bull run in the currency threatens Japan’s export competitiveness. Seoul too may weigh in with intervention for similar reasons. If they get their wish, China may turn out to have bought close to the top.

Losses might be negligible in the context of a $2.4 trillion reserve account — but political strains would be harder to smooth over. So far, Tokyo and Seoul haven’t pointed their fingers at Beijing for the unwelcome strength of their own currencies. After all, China’s recent monthly purchases of Japanese debt amounted to just a tenth of domestic buying, and China’s buys are unlikely to have come without some prior warning. But the risk is that where China goes, other investors follow.

Neighbourly harmony matters to China. Its economic rise, and push into higher-value goods, already pose a threat to other export-led economies. Wage protests directed against foreign companies like Toyota have not helped. And given China’s growing dependence on intra-Asian trade, risking goodwill on currency experiments hardly looks worth it.  For now, dollar dependency looks here to stay.

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The World should thank China for producing quality products at cheap prices. Billions of consumers are using, consuming and enjoying these products.
Only the USA wants to see the prices of these products to increase so that billions of people will not be able to buy them.

Posted by Jeanmichel | Report as abusive