ORLANDO, Florida, June 28 (Reuters) - Japan and China may be signaling that they want their currencies to stop weakening too much, but the reality is depreciating exchange rates will help give Asia's economic giants the inflation and competitive edge both are currently seeking.
What's more, deepening trade links between the two countries and competition for share of the manufacturing supply chains spreading across the continent mean neither will want their currency to strengthen against the other, if they can help it.
In some ways, China and Japan are joined at the hip. Both are pursuing super-loose monetary policy that is running counter to most of the world - Japan to generate inflation after 30 years of battling deflation, and China to spring its economy from a post-lockdown funk and stave off the threat of deflation.
As beggar-thy-neighbor foreign exchange depreciation pressures bubble up across Asia, the attraction of a weaker exchange rate grows. In terms of bilateral trade between China and Japan, the attraction is equally clear.
China's yuan and Japan's yen this week hit their lowest levels against the U.S. dollar since last November, and on a broader real effective exchange rate (REER) basis their weakness is even more pronounced: the yuan is at a nine-year low and the yen is less than 1% away from a fresh 50-year low.
All else equal, a cheaper currency boosts exports, even though the benefits are less clear cut in a world of deeply integrated supply chains, muted global demand, and generationally steep global inflation and interest rates.
But any advantage is worth pursuing. Some 75% of the global installed capacity for semiconductor chips - a key component of the computing, communications, energy and auto industries - is concentrated in East Asia, according to the Asian Development Bank.
"If the game is getting the weakest exchange rate on the block, Japan is winning, even though it is not clear the game is worth playing," said Steven Englander, head of G10 currency strategy at Standard Chartered.
REER-VIEW MIRROR
The yen has fallen 9% against the dollar this year, the worst performer of all the established Asian currencies against the dollar. It is back to the 145.00/dollar area that sparked a record $60 billion of yen purchases from Japanese authorities in September and October last year.
The Ministry of Finance is concerned that yen-selling is gathering unwarranted momentum, but absent a clear and notable tightening of monetary policy, how long will verbal or actual intervention support the yen?
Beijing will be watching closely. China is Japan's largest trading partner, Japan is China's third-largest individual nation trading partner, and bilateral trade is worth around $370 billion annually.
The relative value of the yen and yuan matters.
According to Bank for International Settlements, the yen has an 11.5% weighting in the Chinese yuan's broad effective exchange rate, while the yuan accounts for almost a third of the yen's broad effective exchange rate value.
Remarkably, the yen has depreciated 25% against the yuan over the last three years, giving corporate Japan a substantial competitive advantage over China Inc. It is one reason Beijing's action this week to stem the yuan's fall may not be replicated often or forcefully.
The yuan is within touching distance of the 7.30 per dollar mark that was touched late last year for the first time since 2007. Its 'REER' value is the lowest since 2014, having slumped 15% since March last year and 7% so far this year - substantial moves for a currency that doesn't float and is tightly managed.
Brad Setser, senior fellow at the Council of Foreign Relations, says China's failure to generate more consumption-led growth is holding back the economy and forcing it to rely on a familiar crutch - exports.
"China's domestic weakness is leading China to cling to the export market share it gained in the pandemic," he tweeted on Tuesday.
Essentially, China wants the competitive edge and boost to inflation from a weaker yuan - inflation has virtually evaporated as the economy has slowed - without the risk to capital outflows a sharp depreciation poses.
But Beijing is aware that a weaker yuan is no automatic panacea. Its 'REER' value has fallen 15% since March last year and 7% year to date, yet exports are shrinking and GDP growth forecasts for this year are being slashed.
If China, the continent's economic powerhouse, allows the yuan to depreciate further, other Asian countries will be minded to allow their currencies to weaken - in an orderly fashion, of course - to remain competitive. Especially Japan.
(The opinions expressed here are those of the author, a columnist for Reuters.)
(By Jamie McGeever)
