Asia Weekly

A Lengthening Shadow

Week Ended: March 5, 2010

Deteriorating fiscal conditions in Greece have recently injected a fair amount of drama into global financial markets. At the center of the storm is the stability of the Euro: Greece’s weak finances may force other Eurozone members to come to its rescue, or otherwise risk financial panic in the currency markets. Yet even as the economic imperative to do so is clear, the political motivations may not be—Germany has apparently balked at providing a bailout to one of the Eurozone’s most profligate members. This political tension has only emboldened some skeptics of the currency who have long argued that it is less an economic project than a political one—an ill-fated attempt to bind an ever-widening group of disparate nations.

The ruckus in Europe has shifted attention away from a very different sort of currency realignment that may be gradually taking shape in Asia Pacific: monetary policies formed in China seem to be carrying greater weight beyond the country’s own shores, even though there is no formal agreement that would dictate so. It appears that Asia Pacific’s various economies are slowly but notably managing their monetary and interest rate policies in greater harmony with the Chinese economic cycle, whereas previously the dollar standard—with interest rates determined by the U.S. Federal Reserve—held total sway.

Admittedly, the data points behind this trend are disparate, and may yet dissipate. However the most explicit evidence that Chinese economic policies cast a longer shadow in the region came on February 2, when the Reserve Bank of Australia (RBA) chose to leave its key policy rate unchanged. Among other factors underpinning its decision, it cited an attempt by Chinese authorities “to reduce the degree of stimulus to their economy.” While we do not follow central bank policy announcements closely, it seems to us that such cross-border references are rare. The RBA’s rate decision shocked financial markets, which had anticipated a rate increase in light of domestic conditions; the Aussie dollar fell sharply lower in response (though it has since recovered; the RBA has also since raised its policy rate, in early March).

Developing a unified monetary framework within Asia Pacific is unlikely in light of the region’s history; the region holds too many memories of conflict and mutual distrust. Forging a unified currency out of such a construct is even less likely. However, what may occur is a gradual and de facto harmonization of interest rate cycles, dictated by the business cycles of the largest economies in the region. This may ultimately prove to be a more sustainable union. While a political project would likely fail to get off the ground, Asia’s currencies and interest rate cycles may align based on underlying trade flows, capital markets and other linkages in the real economy.

Andrew Foster
Portfolio Manager
Matthews International Capital Management, LLC

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The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Matthews does not accept any liability for losses either direct or consequential caused by the use of this information.