“It’s our dollar, but it’s your problem.” This famous musing from Nixon-era Treasury Secretary John Connally is about to gain new currency as the dollar becomes Asia’s nightmare.
South Korea is on the front lines as much as any economy as President Donald Trump telegraphs the next phase of his trade war. Until now, this shift has been more aspiration than official White House policy. Hints in January that Trump wanted a lower dollar fell by the wayside as US growth accelerated.
That’s now changing, and in ways sure to slam markets already reeling from Trump’s tariffs.
First, Trump Treasury Secretary Steve Mnuchin ratcheted up the pressure on China. On October 12, Mnuchin said he “expressed my concern” with officials over the yuan’s 10% drop since March. He noted that, now, “as part of any trade discussions, currency has to be part of the discussion.”
Next, it was Japan’s turn. On October 14, Mnuchin rocked Tokyo with news the US will demand free-trade talks include a currency manipulation ban. That’s a dreadful turn of events for Prime Minister Shinzo Abe’s reflation scheme. Since December 2012, Abenomics sought to boost wages and defeat deflation largely through a 30% drop in the yen.
Seoul won’t get off easy. The won’s 5.6% drop versus the dollar is enough to put President Moon Jae-in’s economy in harm’s way. Yes, Moon’s team managed to avoid a clear “side deal” on won depreciation. But the tweeter-in-chief in the White House is sure to bash Moon’s Blue House if the won falls further.
The collateral damage problem is another threat. Trump’s tariffs of 25% on steel and 10% on aluminum were bad enough. So were his 25% levies on $250 billion of Chinese goods. Threats to raise that number to $500 billion would slam Asia’s main growth engine. His proposed 25% tax on imports of cars and auto parts would upend the Asian supply chains on which China, Japan and South Korea rely.
A dollar depreciation is the next horror. There are two forces that could send the reserve currency sharply lower. One, official White House maneuvers to try to resurrect a US manufacturing industry. Two, markets turning against Trump’s irresponsibility.
Can Moonomics get off the ground?
The first would complicate Moon’s pledge to engineer a “trickle-up” economics windfall for South Korea’s 51 million people. The 16.4% jump in minimum wages and stimulus spending were decent starts. But neither step will make a marked dent in the 9% youth unemployment rate. And in fact, evidence thus far points to the minimum wage cutting deeply into job growth as SMEs cut hires.
Last December’s tax hike for companies with taxable income exceeding 300 billion won increased to 25% from 22% also was a sound start. It created quite a contrast from Trump, China’s Xi Jinping and Japan’s Shinzo Abe going the other way, stepping up corporate welfare policies.
But turning an economic model upside down requires nothing short of a Big Bang and Moon – like most presidents before him – has been glacial about curbing the dominance of the chaebol, Korea’s family-run conglomerates.
He needs to intensify anti-monopoly regulations to give small-to-midsize companies greater space to thrive. Seoul should punish corporate giants hoarding massive cash stocks that could be shared with workers. Officials should curb cross-shareholdings, internal mergers within conglomerates that strengthen family control, de-emphasize seniority-based promotions and empower women.
A surging won makes any of these reforms harder to pursue. Yet, as rough as a Trump-led drop in the dollar would be, a market-driven repudiation of the dollar could be far worse.
Will markets push back?
In recent weeks, 10-year Treasury yields spiked to the highest levels in seven years. Traders, it seems, are growing wary of Trump’s fiscal overreach. His Republican Party’s $1.5 trillion tax cut poured tidal waves of stimulus into an economy already at full employment, fanning inflation risks.
On top of Washington’s debt load heading past $20 trillion, Trump’s party just okayed spending bills that push the budget deficit to an unprecedented $1 trillion. Might Trump cost America its remaining AAA ratings?
Trump’s brawl with the Federal Reserve heightens risks. Since assuming the Fed chairmanship in February, Jerome Powell – who Trump hired – has continued a tightening cycle that began in 2015, much to Trump’s chagrin. He called Powell’s policies “crazy,” spooking markets.
Such broadsides, and unpredictability, have Washington’s Asian bankers losing sleep. Beijing and Tokyo own a combined $2.3 trillion of US government debt. Seoul is exposed to the tune of $105 billion. So, Trump’s bombast is uniquely personal for Asia’s biggest economies.
If that’s not unsettling enough, what if both risks unfold simultaneously? While Trump is knocking the legs out from under the dollar, hedge funds and Asian central banks may be teeing up enough sell orders to make the 2008 “Lehman shock” seem quaint by comparison. Buckle your seat belts as the linchpin of global finance gets trumped.
That puts directly at risk Korea’s ability to grow 2.9% next year. At best, it makes Moon’s job harder. At worst, the 12 months ahead could see financial chaos the likes of which Asia hasn’t seen for 20 years.