In Tokyo, Bank of Japan Governor Kazuo Ueda is searching for an exit from 23 years of quantitative easing. However, the answers he seeks could lie more in Beijing.
Japanese policymakers are as surprised as anyone by the underperformance of China’s economy. Back in January, Team Ueda fully expected a powerful growth boost from Asia’s biggest economy that buttressed the argument for higher borrowing costs. Instead, Japan and its neighbours are grappling with the fallout from Chinese deflation, overcapacity and dithering on efforts to end the property crisis. Even if Chinese exports are thriving, weak import activity is being felt throughout the region.
For Ueda to feel comfortable tapping the brakes, he must believe China will add more economic energy than its domestic troubles are subtracting. So far, there is scant evidence that’s going to happen in 2024.
Ueda is hardly alone. Over in Seoul, Bank of Korea officials know that the 2.7 per cent growth that many expect for Asia’s fourth-largest economy is China-dependent. South Korea’s export-driven model doesn’t work when the world’s biggest trading nation is struggling.
The same is true of officials in Bangkok, Jakarta, Kuala Lumpur, Singapore, Taipei and elsewhere in the region. This is particularly true as the “higher for longer” era in the United States looks set to persist as the US Federal Reserve slow-walks interest rate cuts.
Europe, meanwhile, is hardly booming as German growth stagnates. The geopolitical scene is chock full of potential landmines that could shake Asian markets. They range from Russia’s invasion of Ukraine to increased provocations from North Korea to Saudi Arabia’s ambitions to boost oil prices to a US election cycle that is making trade wars great again.
One reason these headwinds are so worrying is how unexpected they are. Another is that top-line Chinese growth rates mask deeper weakness below the surface. A case in point is the ways in which China’s all-important property sector is descending further into turmoil.
In May, new home prices in China fell the most since 2014. Industrial production came in weaker than expected, too, suggesting the 7.6 per cent jump in May exports year on year might not be sustainable.
Thickening the plot for Asia is how a falling yen might alter decision-making in Beijing. As Ueda’s team in Tokyo delays ending quantitative easing, the yen is sliding anew. The burning question is whether the currency’s 13 per cent drop this year prods China to engineer a weaker yuan.
No immediate step might do more to boost China’s prospects and curb deflationary pressures than a more advantageous exchange rate. However, count the ways that might backfire as the US carries out what could be one of the most chaotic elections in its history. Nothing would put US President Joe Biden’s Democrats and former president Donald Trump’s Republicans on the same page faster than China devaluing the yuan.
It takes two to wreak global economic panic. The US dollar’s surge is hoovering up global capital at a rate not seen since the mid-to-late 1990s. That episode didn’t end well for Asia, culminating in the region’s 1997-98 financial crisis.
The US dollar’s latest rally has Asia engaging in something of a reverse currency war. Governments are working to strengthen exchange rates to limit the risks of importing inflation and reduce the odds of another capital flight.
Yet this impulse collides with worries about China’s trajectory. Part of the confusion is why President Xi Jinping’s inner circle has been so slow to stabilise the property sector and deployed scores of half-measures amid declarations that bold reforms are afoot.
Here, the lessons from Japan loom large. The biggest is that when battling deflation, it is best to act quickly and with overwhelming force to restore confidence. Scores of timid steps in the 1990s to address a bad-loan crisis treated the symptoms of Japan’s trauma, not the underlying causes.
That is why Japan’s central bank remains trapped in quantitative easing quicksand. Since taking the helm in April 2023, Ueda has passed up every chance his team has had to normalise rates. Now, as China slows, Japan might have missed its window to unwind its US$5 trillion balance sheet.
There is also renewed speculation that China might try its hand at quantitative easing. Earlier this month, former People’s Bank of China adviser Yu Yongding argued it was necessary to first “shake off the thinking” that quantitative easing is a taboo “so that we can launch it immediately when needed”.
Whether China would fare better with ultra-loose policies than Japan is anyone’s guess. As we learned from Japan, though, quantitative easing can’t resurrect animal spirits unless policymakers cut bureaucracy, modernise labour markets, increase productivity and empower the female half of the population.
China is likely to suffer the same fate without bold supply-side actions to reduce the size of the state sector. It needs a creative, transparent strategy to get distressed assets off property developers’ balance sheets and address the huge amounts of off-balance-sheet debt weighing on local governments.
As officials in Beijing drag their feet, economists across Asia will find themselves at the drawing board reducing growth prospects while governments are scrambling for new drivers of growth.
William Pesek is a Tokyo-based journalist and author of “Japanization: What the World Can Learn from Japan’s Lost Decades”