Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

The coming wave of competitive devaluations in Asia

We are today seeing a significantly altered re-run of the 1997
crisis in large parts of Asia. Once again, there is a “sudden
stop” and reversal of capital flows. The big difference is the
the large reserves that Asian countries accumulated during the

Korea was the first to realize a few weeks ago that unless they
threw the reserves away in a futile defence of the currency, the
reserves were large enough to cover the sovereign debts as well as the
debts of the banking system. A crashing currency could bankrupt
reckless companies, but the country would be safe. They have therefore
let the currency collapse and have been free to use the reserves to
lend to their over extended banks. In 1997, Asians did not have this
option. They thought that the only way to prevent a run on the country
was to defend the currency and signal to the rest of the world that
they were sound.

I believe that the Korean currency depreciation of recent weeks is
going to be the new pattern in Asia. Under normal conditions, most
Asian governments are suborned by their corporate sectors, but under
conditions like this, these same governments would let reckless
companies stew in their own brew. An added incentive this time is that
with a slowing global economy, the Asians are going to be fighting for
a share of a shrinking export pie. We will therefore see more of the
beggar thy neighbour game that the Europeans and Americans played
during the great depression. This time around, the western world does
not seem inclined to play this game leaving the field wide open to the

We in India know how ten years ago the Koreans used their
depreciated currency to capture the white goods market in India. Now
that the won is again at 1400 (closer to 1450 as I write) to the
dollar, I see an even bigger onslaught by the Koreans because the best
run conglomerates are in far better shape than they were in 1998. It
will not just be white goods but every industry where there is global
excess capacity (which probably means just about everything).

The won will also put pressure on Japan to embark on large scale
intervention (possibly half a trillion dollars over the next year or
so) to keep the yen down. The Japanese are possibly more concerned
about the euro-yen cross today and their intervention could indirectly
help the Europeans. But the Chinese would feel the heat of a declining
won and yen.

For a couple of months now, the smart money has been shorting the
renminbi (what a change a few months makes!). As Chinese exports slow
down, a depreciation of the renminbi would be just what the doctor
ordered. Since probably as much as half a trillion dollars of hot
money flowed into China in the last couple of years, the Chinese
government would just have to sit back and watch this money flow out
and pull the renminbi down as it leaves. I would not be surprised if a
year from today, Japan once again has the world’s largest
foreign currency reserves.

Competitive devaluation by Korea, Japan and China would leave India
with no choice but to let the rupee fall to levels which would be
frightening (if not bankruptcy threatening) to those who have been
stupid enough to borrow in dollars. Beggar thy neighbour is a very
ugly game when countries start playing it in right earnest.


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