Currency trends

Trade war looms over differences between US and China’s perception of their currency values.

SINCE the opening up of its economy three decades ago, China has been prospering and powering ahead with enviable high growth rates over the last 10 to 15 years. Providing a low-cost environment, many manufacturing companies sprouted across the country, producing a wide range of goods (from toys and textile to electrical and electronics) to satisfy the demand of global consumers. With that, China has earned the tag of the “factory of the world”.

From an impoverished nation to a socialist market economy, the miracle of China’s growth is mainly attributable to its thriving exports. The growing global demand for China’s produce has been pinned on the fact that the prices of its goods are found to be much more cheaper than those produced in other countries.

For some countries, particularly developed nations such as the United States, however, there’s been a negative effect. With cheap China goods flooding the market, these developed nations claim that many of their local manufacturers have been put out of business because they could not produce goods to match the prices of China goods.

On the Chinese side, the government continues to intervene in the financial markets, in particular over the pegging of the exchange rate of the yuan against the US dollar, to keep the prices of its goods competitive in the global market and as a means to further promote its exports and attract foreign direct investments.

While the strategy has worked well in its favour, China has over the years faced continuous pressure from developed nations, particularly the United States, to allow its currency to appreciate.

The yuan was pegged at 8.27 per US dollar from 1995 to mid-2005. The Chinese government subsequently adjusted the value of its yuan upwards to 8.11 per US dollar and lifted the peg and allowed its exchange rate to fluctuate against a basket of currencies, including the US dollar, euro and yen.

In July 2008, the Chinese government allowed a 21% appreciation of its currency against the US dollar and the value of yuan has since been pegged at around 6.83 per US dollar to this day.

Many economists from developed countries claim that the yuan is currently still undervalued by a wide margin of between 20% and 40%. Hence, the rising pressure from the international community, particularly over the week, on China to let its currency appreciate.

For instance, the International Monetary Fund (IMF) and the World Bank on Wednesday lent their support to the United States to urge China to allow its yuan to float.

Addressing the European parliament, IMF managing director Dominique Strauss-Kahn said “this cannot be avoided; in some cases exchange rates have to appreciate, and that’s the debate which is very well-known about China and the value of the yuan”.

The Chinese government manages to keep its yuan at the pegged rate by buying US dollar. The US government calls this currency manipulation, and will decide by next month whether to declare China as a currency manipulator. The sentence will be stiffer tariffs for all China goods to compensate for the unfair advantage that the dragon economy has been enjoying all these years.

While stating its reluctance to adjust the value of its currency, China has called such pressure on it to comply as a trade protectionism measure on the part of the US government. The Chinese government has indicated that it would respond with the same sort of import tariffs on US products should its export goods be levied with tariffs by the US government.

Economists see such development as a rising risk of trade war between the two major economies, which could be destabilising for global economy.

“With two giants fighting, there will surely be some spillover effects on the other economies in the world,” RAM Holdings Bhd chief economist Dr Yeah Kim Leng says.

There is certainly room for accommodation, especially on the China’s side to allow its currency to appreciate. But economists point to China’s main concern on the impact of the yuan appreciation on its industries, which are mainly export-driven. In other words, many factories, particularly those that are labour-intensive and have low profit margin, could possibly close down if global demand for their goods fall, as a higher yuan could render their goods less competitive in the global market.

While Western economists say the appreciation of the yuan is the most effective way to address the global trade imbalances, some Asian economists contend that currency alone cannot help fix the situation.

Put house in order

“Developed nations have to put their house in order first, and not just depend on Asia to adjust their currencies,” CIMB Research chief economist Lee Heng Guie explains, pointing to the low savings rates as one of the key issues that developed nations has to address.

Nevertheless, many believe that there will be a gradual appreciation of the Chinese currency. Some quarters say the appreciation of the yuan would likely start towards the second half of this year, as its domestic economy continues to strengthen amid the country’s rising inflationary pressure.

“There are benefits and economic justification for China to allow its currency to appreciate,” Yeah says.
These include the need to control inflation and prevent the overheating of its rapidly growing economy as well as to increase its purchasing power to import more goods and services and to acquire foreign assets, Yeah explains.

Regional currencies, including the ringgit, will likely track how China can accommodate to the pressure on its currency to appreciate in the days ahead.

“Certainly, any movement of the yuan, which is the anchor currency of the region, will affect the movement of regional currencies, including the ringgit,” Lee says.

Over the past one year, the ringgit has been strengthening against the US dollar. Year to date, it has gained about 3.5% against the greenback to trade at around RM3.30 per US dollar.

As it stands, there are some contrasting views over the performance of the ringgit towards the end of the year. While many believe the Malaysian currency will strengthen as a reflection of its strengthening economic fundamentals (or as it tracks the trend of the possible rise in yuan), a local bank analyst sees the possibility of a weaker ringgit by the end of the year.

He reasons that the strength of the US dollar would likely return by the second half of the year on expectations that the US Federal Reserve would raise its interest rates sooner than expected.

For a worse-case scenario, he values the ringgit at RM3.45 per US dollar by year-end, while others think the value will stabilise around RM3.30 per US dollar.

“It’s still fluid at the moment as the trends of the economy keep changing. Many factors come into play, and we need to monitor developments in other economies,” an analyst says.

Source: By cecilia_kok@thestar.com.my

Monkey rules

THE banana kingdom was in deep trouble. After the failure and rescue of Banana Bank, the government poured lots of funds into the bank and enjoyed a temporary revival. But the economy fell back into recession and unemployment grew.

The king was very worried, because his ministers gave him lots of conflicting advice. The public blamed the bank managers for incompetence and insisted on more regulation.

The bankers complained that more regulation was killing the golden goose that gave the kingdom so much prosperity before. No one was happy.

In desperation, the king summoned the wisest of the monkeys – an old sage well-known and respected for his frugality and his integrity.

“Please help me get out this problem, Master. Teach me how to deal with our difficulties,” the king pleaded.

“Remember the golden rule,” said the sage. “He who has the gold rules. But who has the gold now?”

“You are right, wise sage”, admitted the king. “We spent so much money rescuing Banana Bank that the kingdom is deep in debt. In fact, the bankers are now richer than before and are major lenders to the kingdom.”

“So are you the ruler or the bankers? You must know the monkey rules, before you can rule them,” said the sage.

The first rule is “never let monkeys look after bananas.”

“Yes, I learnt this to my cost,” said the king, “but the monkey was so convincing because he was able, brilliant and well dressed.”

“He went to the best business schools and was so polite and able to explain things so beautifully that I felt it was in my best interest to trust him.”

“Exactly,” smiled the sage. Did the monkey banker not say to you, “you pay peanuts and you get monkeys?’’
“Yes and because of that I paid him a lot of money and bonuses.”

“Rule number two is, an expensive monkey is still a monkey.”

“So, the crisis must be due to the derivative banana products which are very bad and dangerous? We should ban them,” said the king.

“The derivative game looks very complicated, but it is very simple. You should not look at all the banana leaves, but look at the banana trees. Where is the fruit? Who has eaten the bananas? The banana derivative products are only tools, which can be both good and bad. Guns do not kill people, only people kill people. So you should not blame the derivatives.”

“You are right. But where did I go wrong in the bank rescue?” asked the king.

“There is a time for a tree to live and a time for a tree to die. A tree dies when it has taken all the goodness from the soil. When it dies, it returns the goodness to the soil so that new trees to grow. Life is cruel, but for every death there is new life. Instead of allowing a bad and sick tree to die, you rescued the dying tree. Now the sick tree is sucking more goodness from the soil, so that new trees cannot compete for the sun and soil.”

“But I did it for the good of everyone”, protested the king.

The sage nodded. “You have a good heart, but good intentions do not always have good outcomes. The monkey understands well that the secret of making money is to buy low and sell high. When you rescue him, you are buying high and selling low. If you always buy high and sell low, how can you win?”

Rule number three is therefore: “When you rescue a monkey, it’s no longer the monkey’s problem, but your problem.”

“I now understand that it’s all the monkey’s fault,” said the king.

“No,” said the sage firmly. “Monkeys are not born bad. Neither are monkeys born good. It is not wrong for them to love bananas. You put a monkey in charge of monkeys,” quipped the sage, “because you thought you wanted an expert who understood how monkeys behave. But management that is part of the problem cannot be part of the solution. They will want to protect their interests.

“If you are not careful, the monkeys will become the owners of the banana kingdom, not you, my lord.”

Rule number four is that there are no permanently good monkeys or permanently bad monkeys. There are only permanent interests.”

“You are right”, admitted the king. “I now see that tools and monkeys cannot be my master. But I still blame the monkey for making a mess of the situation.”

The sage shook his head sadly and sighed deep and long.

“Your highness, it was you who allowed the monkey to look after the bananas. You who appointed a monkey to look after the monkeys. So now that the bananas are gone, are you the monkey or are they the monkeys?”

Rule five is that you are ultimately responsible for your own mess.

The king at last saw the light. “You are wise, my master, but what should I do?”

“You are kind and your ministers push only those policies that are popular. But what is popular today is not what is wise tomorrow. If the monkeys eat all the bananas, there will be no seeds for the trees to grow. If there are no trees, there are no bananas and everyone will starve. So even monkeys understand that short-term excess consumption means starvation tomorrow.

Rule six is you have to be cruel to be kind. Do what is necessary for your people, even if it means sacrificing yourself.”

The king saw the light. He gave up his kingship for his son and asked that he and his children swear to learn the Monkey Rules. The first thing the new king did was to banish the monkey banker, clean up the system and ordered that the banana plantations be rejuvenated.

Then the old king followed the monkey sage up the mountain to become a monk.

Source: THINK ASIAN, By ANDREW SHENG

● Datuk Seri Panglima Andrew Sheng is adjunct professor at Universiti Malaya and Tsinghua University, Beijing. He has served in key positions at Bank Negara, the Hong Kong Monetary Authority and the Hong Kong Securities and Futures Commission, and is currently a member of Malaysia’s National Economic Advisory Council. He is the author of the book, From Asian to Global Financial Crisis.

Strategy to prevent systemic failure

Applying group-think and sell-by date concepts in business

LAST time I discussed whether lack of board diversity was the cause of group-think and failure as a result. My view is that lack of diversity per se does not create group-think, though board dynamics do.

Dominant CEOs and chairmen are often highly successful people and it is this track record of success that makes it hard for independent non-executive directors to challenge them.

Yet challenge constructively they must because strategies have sell-by dates and so recipes for past success can become guarantees of future failure – at its worst, manifested in systemic failure.

For 20 years, Jack Welch followed an immensely successful growth strategy of milking General Electric’s (GE) industrial businesses to invest in the faster-growing financial services sector – to the point where banks complained GE had an unfair competitive advantage as a financial institution because of its AAA rating resulting from being classified as an industrial company.

Their successful lobbying stopped GE continuing to grow in financial services. Welch’s successor Jeffrey Immelt took over a company whose growth engine was in neutral, having to face the problem that the industrial businesses were short of new products because not enough had been invested in research and development (R&D).

Turning that R&D deficit around took years of cash-consuming investment with no immediate payoff. So it is hardly surprising that compared with the Welch years, the Immelt years do not seem stellar. Yet Immelt’s problems were of Welch’s making.

I am sure that it must have been very difficult for independent directors to challenge Welch’s strategy and argue that his drive into financial services was unwise – all the more so since the strategy was lauded in business schools and written up in top-selling management books.

Group-think does not just happen within the board – conventional wisdom is just another form of groupthink and directors on GE’s board from diverse backgrounds would have been influenced by what they had read.

In the case of GE, the strategy sell-by date was caused by continuing with it for too long. Perhaps this is what Toyota is facing at the moment. For decades, its strategy has been astonishingly successful. It reached global No. 1; it had an unparalleled reputation for quality; it taught the world “Lean Manufacturing” – how to make not just cars but anything with concepts such as “Just In Time”, “Kaizen” and quality circles.

It was the low-cost leader in its industry that also managed to differentiate itself with luxury models such as Lexus, disproving Michael Porter. It was hugely cash rich, so that it could almost be regarded as a bank. Such a track record of continued success must have been immensely hard to question, regardless of whether the board had the diversity recommended by The Economist or not.

“If it ain’t broke, don’t fix it” is just another way of describing group-think and of failing to recognise that strategies do have sell-by dates.

In Toyota’s case, its chase for market share may have led it to drive down supply chain prices just that bit too far, outsourcing to one new factory in a new country too many, where its cardinal principle of quality was not adequately understood.

Sharing platforms across models, sourced from all over the world only amplified any glitch so that one defect affected millions of models across the range, damaging the brand across the board as opposed to being containable in just the affected model.

Just as it will take GE time to recover from going past its strategy sell-by date, it may also take Toyota longer than people realise because unwinding what has been done so well for so long is really difficult, if that is what it has to do to recover its reputation.

That brings me to systemic failure, often the result of group-think on a board with diverse backgrounds – though the groupthink here is of a different kind – the kind that caused the global financial crisis.

This is group-think caused by the herd instinct: the argument that if other people are doing it and making lots of money, then we should be doing it too. This may not be sound thinking, but it reflects the pressure boards of financial institutions were under from shareholders and analysts when their results were being compared with other companies that were in opaque derivatives.

When one or two institutions behave irresponsibly to make supernormal returns, it does not threaten the system (the famous “free rider” problem in economics), but for all to do so will cause the system to collapse.

That is what happened with subprime, collateralised debt obligations and credit default swaps, termed “dancing” by Chuck Prince, then CEO of Citigroup, when he explained that everybody was on the dance floor as was Citigroup – the trick being to get off before the music stopped – i.e. before the strategy had gone past its sell-by date.

The writer is CEO of Securities Industry Development Corp, the training and development arm of the Securities Commission.