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The most remarkable thing about this year’s rallies in the yen and won is what’s not happening in Tokyo and Seoul: panic.
Like clockwork over the last decade, any jump in exchange rates would have had Japanese and South Korean officials – desperate to keep export prices competitive – squeaking with alarm.
Yet this time the usual suspects are silent and the usual catchphrases – from “we’re watching market trends urgently” to concerns about “one-sided” trades – are largely absent.
One reason is a recognition that the yen and won are rising for the right reasons. There is also, perhaps, a nascent realization in both capitals that the trend of rising currencies has more pros than cons.
Falling dollar, rising Asia
No doubt, the dollar’s travails are a big factor in both currencies’ 4 percent appreciation against the greenback this year.
With the surging US national debt now exceeding $27 trillion, faith in the reserve currency is waning fast. China, by contrast, has contained its coronavirus fallout and engineered an economic recovery without the aggressive stimulus unleashed in the US.
This anchoring effect is buoying yen and won-denominated assets.
Nor is the chaotic transfer of US presidential power from Donald Trump to Joe Biden doing Washington’s AAA credit rating any favors. Citigroup cites political squabbling over new Covid-19 stimulus among the reasons why the dollar may drop as much as 20% in 2021. The Bloomberg Dollar Index is down about 12% since March.
Yet the rallies in the yen and won, like the yuan, are grounded in the realization that we’re seeing what Charles Gave of Gavekal Research calls “an Asian moment.”
“Many Asian countries have managed their economies and the pandemic relatively well, and markets are paying attention,” Gave notes. He adds that many Asian nations, Japan and Korea included, even “overlooked their recent differences with China to finally sign a trade pact, reinforcing the trend toward regional integration of supply chains.”
Caveats abound, of course. There’s ample reason to criticize Tokyo’s structural reform efforts over the last decade. The same goes for South Korea, which has made scant progress recalibrating engines away from monopolistic “chaebol” family conglomerates to smaller companies.
But investment decisions are relative. And at a moment when the US is stumbling badly and Europe looks increasingly wobbly, Asia is emerging as the lesser of the three evils.
Nowhere is that truer than aging, uncompetitive Japan. With the biggest debt burden among developed nations and the most aggressive monetary easing anywhere, the yen makes for an odd safe haven.
Add in fears of another wave of Covid-19 to pull the floor out from under growth. Prime Minister Yoshihide Suga is currently cobbling together another emergency spending plan. That comes on top of the $2.2 trillion of aid – 40% of gross domestic product (GDP) – Tokyo has thrown at its economy since April.
The yen tends to rise a bit in times of trouble as companies repatriate overseas profits to paper over domestic weakness. It also plays a safe-haven role amid “risk-off” shifts in investor sentiment. This time, though, its advance is part of a broader vote of confidence in North Asian currencies.
And the region would be wise to run with it.
Vote of confidence
Aside from the technical and emotional reasons why punters are buying yen and won, it denotes collective confidence in the Japanese and Korean economies. This “Good Housekeeping” seal of approval is a necessary ingredient to pull in foreign capital destined to stay for the long run, not just hot-money flows.
Steady flows of this longer-term capital strengthen national balance sheets, cap bond yields, buoy stock values and help keep inflation under wraps.
Moreover, a rising exchange rate can prod entire economies to move upmarket, championing innovation and services-based growth over exports.
Yet Asia has long been obsessed with maintaining weak exchange rates. After the 1997-98 financial crisis, the region accelerated into a collective race-to-the-bottom on exchange rates.
The biggest push came from the top, Japan, Asia’s most developed economy and traditional growth model. In 2004 alone, Tokyo spent the then-equivalent of Indonesia’s GDP depressing the yen.
A decade later, then-Prime Minister Shinzo Abe made a 30% yen devaluation the core of Tokyo’s most ambitious reflation gambit in years. That inspired peers throughout Asia – from Seoul to Jakarta – to intervene in currency markets early and often.
The dark side of this exchange-rate tug of war – essentially, synchronized corporate welfare on an epic scale – was complacency.
In both Tokyo and Seoul, it took the onus off corporate executives to innovate and restructure. Why bother with such heavy lifting when Ministry of Finance and central bank officials have your back?
This dynamic, more than any, explains why Abenomics was more sugar high than revolution for Japan Inc.
A competitive exchange rate reduced the urgency to recalibrate operations, boost productivity and dream up game-changing technology and products of the kind that wowed the globe in the 1980s. And the lack of supply-side upgrades limited the ability of monetary stimulus alone to end deflation.
Korea suffers from similar inertia. A weaker won in the 2000s and 2010s did little to modernize labor markets, empower entrepreneurship broadly, increase productivity or narrow the gender pay gap. This relative dearth of supply-side disruptions reduced Korea Inc’s confidence to take big risks or even smaller steps like sharing profits with workers.
If only North Asia had gone the way of Germany over the last decades, argues Stephen Jen, CEO of advisory firm Eurizon SLJ Capital.
German leader Angela Merkel has overseen a highly developed, high-labor-cost economy with a track record of not just adapting to strong exchange rates but harnessing them to increase competitiveness.
Rather than lobby Berlin to intervene, German manufacturers tend to use them as an excuse to streamline corporate structures and hone competitiveness.
Strategist Nicholas Smith of CLSA Japan notes that there are indeed examples of companies adapting. Tire giant Bridgestone, for example, “is a well-run company paying almost a 4% dividend yield, benefiting from cheap input costs – and benefits from a strong yen,” he says, adding it’s a “high-quality value stock worth a look.”
The pull of the yuan
China’s rise makes such recalibrations more urgent than ever for Japan and Korea. And Beijing’s tolerance for a stronger yuan may be giving its Northeast Asian rivals greater confidence to let their currencies drift higher, too.
“Today, it’s not the yen that investors need to watch, but the renminbi,” says Gavekals Gave. “And in the last few months the renminbi has been strengthening, with important implications for everything from global bond yields, through energy prices, to the relative performance of US growth and value stocks.”
The spillover effects for Asia are significant. China’s outperformance versus the US could increase as Trump leaves scorched earth in Biden’s path.
One example is the nearly 14 million Covid-19 cases Trump bequeaths. Another is how the White House and Trump’s fellow Republicans in the Senate are slow-walking additional Covid-19 stimulus efforts. And Treasury Secretary Steven Mnuchin is reducing the Federal Reserve’s latitude to support the economy on the administration’s way out.
The expiration of emergency benefits expiring at year-end “supports our long-standing call for continued dollar weakness,” says strategist Win Thin of Brown Brothers Harriman.
Yet the yen’s rise isn’t just a weak-dollar phenomenon. The Nikkei 225 Average is up 17% over the last 12 months, more than triple the 5.6% gain in the Dow Jones Industrial Average. Much of Japan’s outperformance reflects foreign capital inflows.
The same is true of Korea’s main Kospi Index, which is up an even more impressive 28% over the last year.
Adding fuel to Korea’s advance is that its economy is growing close to 2% and lacks Japan’s deflation troubles. Also, Kospi stocks are trading at multiples 30 times expected future earnings versus 37 for the Nikkei.
To be sure, China’s resilience is a factor in demand for the yen and the won. Manufacturing activity in North Asia is getting a lift from the mainland’s recovery. Last month, Korea’s purchasing managers’ index rose to 52.9, its highest since early 2011, from 51.2 in October, according to IHS Markit. Japan rose to 49, the highest since mid-2019.
Yet let us give some credit where it’s due. This is a tale of two nations that to varying degrees have avoided the Covid-19 Armageddon plaguing the US, and of two governments not just learning to live with rising exchange rates but preparing to reap future benefits, too.