Where has all the money gone? Of course, part of the explanation is the success of Asia’s central banks in removing vast amounts of foreign exchange flows through sterilization. Even so, a net $700 billion has still leaked into domestic economies. And sterilization tends to push interest rates up as domestic liquidity is sucked out of the system. Again, this has not happened in Asia, where real interest rates are at historical lows.
Now Jonathan Anderson, chief economist, Asia, at UBS, has come up with an interesting explanation of this riddle: no one wants the money. In an era of what Anderson describes as “depression economics”, a lack of domestic demand for imports to offset burgeoning foreign exchange flows and lacklustre domestic investment in Asia has given central banks free rein to mop up money without fuelling inflation or raising interest rates. The phenomenon is graphically evident in the stark differences between Asia’s current account surpluses, driven by export-led growth and a corresponding lack of domestic demand, and the region’s capital account balance, which has been negative every year since the financial crisis.
China and India remain the notable exceptions to this trend: both have relatively strong domestic economies and run current and capital account surpluses, albeit for different reasons. India has seen accelerating inflation as a result of strong investment and credit growth, and China’s closed capital account and domestic credit controls have enabled the government to absorb inflationary pressures thus far.
For the remaining Asian economies, a benign absence of inflation seems like a good thing, and it is, sort of. Despite strong increases in regional stock and property markets, the absence of inflationary pressures and strong inward capital flows suggest that markets are being driven more by a recovery from a period of sustained depression rather than being fuelled by speculative asset bubbles.
That might be good news for the markets in the short term but Asia’s economic imbalances are unsustainable over the long term. The reliance on export-led growth in many of Asia’s economies, coupled with the lack of domestic demand, is akin to flying a jet airliner continuously on one engine. These structural imbalances will be worked out of the system eventually. The manner in which this happens could prove to be painful to Asian markets in the long term.
