-->A FLASH IN THE PAN?
by Chuck Butler

The pan-Asian currency markets are in dire need of a makeover. These economies are critically important and inexorably interrelated to the still-tentative Western recovery. They are characterized by a hodgepodge of exchange rate regimens: fully free-trading currencies in Australia and New Zealand and purely price-fixed exchange rates in China. From everywhere in between, there is the gray scale where, with a wink and a nudge, lip service is paid to the marketplace, while intervention rules the roost.

These exchange mechanisms create barriers in trade, transactions and investing. When the product manager of a company in Japan or the United States sends a price list to Malaysia, what price do they use? In what currency should it be quoted? Can it change throughout the year? Can an investment in a joint venture produce triple-digit profits, only to see a seemingly random governmental change in exchange rates wipe out the earnings? These questions, and so many more, demand answers.

It is time for this community to recognize who they are collectively, and then to begin the long march to the ultimate great leap forward - a single currency to shepherd the economic zone into a dominant role in the 21st century. It is time to create the"Pan."

The required characteristics of the Pan must include full convertibility in all participating countries, coupled with complete transparency; timely and accurate data dissemination; formation of a single central bank; a plan for conversion to use currency daily; a pooling of exchange reserves; and a coordination of fiscal and monetary policy. It's time to form the group and fix the date for the launch - say 2015.

There are certainly enormous political and cultural barriers to overcome. Growth rates, exchange reserves, fiscal policy, monetary policy and the fundamental approach to economic theory stretch from the pseudo-free market Communist government in China to authoritarian capitalism in Singapore. There are countries that don't know they belong in the club and others that might be blackballed as members of this new world coprosperity sphere. And what to do with places like Myanmar? Asia looks as bad as Europe did as the plans for the euro were being set in stone!

There are a number of great reasons for Asian countries to join together to create the Pan. First, here are a few of the obvious:

With a single unit of trade, there is a reduction in transaction costs for exchanging currencies, as goods and services move between the pan-Asian countries. With this benefit comes a broader hedging capability for companies and governments, as one currency can now cover the entire zone. In addition, no one country can upset the apple cart and fix their currency in a vacuum, producing mayhem for investors.

The accumulation of exchange reserves can be concentrated for smoothing, protecting and stabilizing movements. All the regional governments should contribute the current U.S. trillions (that's right) of exchange reserves to an independent privately chartered central bank. From the Asian side of the table, this may be the most powerful argument for the single currency - with central control of exchange reserves, the Pan Central Bank would hold sway over U.S. policy makers, who are debt-burdened to the rest of the world.

When taken together, China and Japan as members of the Pan form a tremendous economic bloc. Japan is already the No. 2 economy in the world, and China is poised to become the largest, even as the growth rate is reduced over the next 10 years. Add in India, and you have the lion's share of the global population. By joining together to form the Pan, along with a diverse group of countries from India to Pakistan, Australia and New Zealand, and to the far flung islands of Indonesia, China and Japan can become the leaders of what will likely be the 21st century's greatest economic story.

In a fiat currency world, it is difficult to determine the intrinsic value of any currency. Letting the market set the pace under the direction of a pan-Asian central bank with rational and coordinated fiscal policy may be beneficial for the world. But even deeper, the prolonged international cooperation that is required may provide the forum for these countries to discuss and engineer solutions to the thornier issues of their underclass, along with religious and caste prejudice. As a distant hope, or perhaps a fantasy, the widespread poverty that is likely the fuse for the exploding distribution of the anti-West message of terrorism can be extinguished by an economic expansion and the replacement of despair with hope.

On the other hand, with political disharmony reigning in East Asia, even talks of currency unification could lead to regional meltdown. Disparate governing bodies - from communism, to military rule, to fledgling democracy - distrust one another. China-Taiwan tensions could erupt into invasive action within the next 12 months. Do they invite North Korea, a belligerent nearby nation with nuclear capability, to join? Will tensions break out if they don't?

Then there's the potential fight over which currency the new one will be based on. Will the potential members agree to a new currency springing from the Japanese yen? Those who bitterly remember World War II will not be on board for that. Next option: basing the new buck on the Chinese yuan? Not with the region already distrustful of the authoritarian administration. Merely floating these options for discussion could fuel deadly skirmishes - or at least brutal trade wars.

Political differences aside, the wide economic gap among the region's nations hampers the single currency idea. To force struggling economies to meet near-unattainable membership standards (think euro criteria) could intensify the divisions, rather than narrow them.

Finally, there's the idea that dealing with a single Asian currency and a single Asian central bank would ease trade relations for the rest of the world. More likely, though, such an alliance would hamper member nation negotiations with trading partners, such as the United States. Rather than dealing with an individual country, where (at least ostensibly) the United States would maintain the upper hand, we'd now be forced to negotiate with an alliance - one with considerably more power than the sum of its parts. It is in this aspect that the interests of the world may diverge most starkly from the interest of Asia.

It's no secret - a single Asian currency means a single Asian central bank - and that would greatly increase the potential for currency crises, precipitating bigger economic bubbles. Central banks by their nature influence currency; this convergence would intensify the punch their manipulations pack.

When the value of a currency has more to do with global politics than with its intrinsic worth, the stage is set for economic meltdown. Rather than let the world markets work for natural balance, central bank politicians (in the guise of economic policymakers) print money and monkey around with exchange - attempting to alter the relative strength of their currencies and dictate a change in the prevailing economy.

These shortsighted measures (theoretically) designed to prop up flagging economies, merely postpone problems - and intensify the eventual crisis. A unified Asian central bank, intent on strengthening its member nations' individual economies, will resort to wide-scale currency manipulations just like any other central bank - only now with an added power punch...directed right in the face of the U.S. economy.

As of June 30, 2004, seven East Asian countries held a combined 14.6% of the U.S. outstanding public debt; and when you discount U.S. intragovernmental holdings, that number climbs to 25.2%. Just two countries hold the lion's share of that total $1.06 trillion: Japan and China. So it's already pretty concentrated.

Already, dollar bears warn of the implications of a dollar dump by China or Japan - such action would send the U.S. currency into a hopelessly downward spiral, literally flooding the market with unwanted greenbacks and deeply depressing the dollar. Why would countries that have been shoring up their forex reserves with dollars want to get rid of them? The economic answer: to hedge against a falling dollar by selling forward, and, at the same time, taking some profits due to extremely low short-term U.S. rates. The political answer: to deliberately trash the U.S. economy, challenging America's position as a world superpower.

The effect of either China or Japan unloading their dollar reserves could put a significant dent in the U.S. economy. Now, picture that $1.06 trillion held by a single unified entity. A combined effort, created by a fused currency system, could impact the entire American financial system: think rate spike and currency devaluation. Those are huge threats to hold over the United States, and they could color virtually every facet of our dealings with the multinational Asian union.

The bottom line? Even attempting to force such disparate economies into a single mold could incite violent political skirmishes in the region. And the creation of yet another mega central bank paves the way for expanded political/financial manipulations...and global negotiations in which the United States no longer takes the chair.

Regards,

Chuck Butler
for The Daily Reckoning