EAST ASIAN UNITY / THE NEW YORK TIMES OP EDITORIAL ( HIGHLY RECOMMENDED READING )

June 22, 2010

East Asian Unity

By PHILIP BOWRING

HONG KONG — Two of the reasons for China’s shift to a slightly flexible exchange rate are obvious: foreign pressure in advance of this week’s G-20 meeting and the need to stimulate domestic demand and dampen inflation. But there is a third: China’s desire not to be seen as frustrating East Asian attempts at monetary cooperation aimed at the eventual creation of an Asian Monetary Fund.

Those efforts are being strongly pushed by Japan and Korea with the support of most of the 10 members of the Association of South East Asian Nations. But China has been an anomaly, on the one hand rhetorically supporting these moves while on the other having economic policies out of step with the region’s big players.

The recent turmoil in Euroland has focused East Asian minds on two issues.

First, the vulnerability of those nations with very open economies to international short-term capital flows. Flows into the Korean won, Thai baht and Singapore dollar became a proxy for China. These currencies became more volatile and tended to appreciate, putting them at a competitive disadvantage to China. Korea and Indonesia have both recently imposed some restrictions on short-term money movement.

Second, as Europe has shown, currency alignment without fiscal prudence and coordination is a recipe for chaos.

There is no Asian equivalent of the euro and there will not be in the foreseeable future. However, last year the Asian countries concerned did agree to a $120 billion multilateral fund for currency stabilization backed by two significant elements.

First, the voting system accorded equal power (28.4 percent) to Japan and China, while giving Korea, as usual, more weight than it’s worth (14.7 percent). The 10 Asean members share 28.4 percent, with Indonesia, Thailand, Malaysia and Singapore being equally weighted.

Although these weights are underpinned more by politics than economics, the idea of an East Asian unit of account based on them is being pushed by some bankers and economists in the forefront of regional cooperation. At the very least it could serve as a useful benchmark showing how far any one currency had gotten out of line with the weighted average of the others. Apply this benchmark to the past 12 months and it would show that most currencies had appreciated and the Chinese yuan had fallen. Hence, China needs to allow its currency to rise to keep it from creating regional disharmony.

Second, Asean plus China, Japan and Korea also made an important step toward mutual surveillance. The 13-member group agreed to establish the Macroeconomic Research Office in Singapore. It is expected to pronounce on national policies as well as regional and global issues that affect financial stability. This may prove toothless but its very creation by countries ultra-sensitive to external criticism is significant.

China is clearly worried that the Japanese and Korean positions on financial issues are taking away the initiative in regional cooperation from China, which has been foremost in pressing trade pacts. But that will remain the case so long as China insists on playing by different rules — including a pegged currency.

Whether regional trade and financial cooperation develop further or get stuck on the rocks of Sino-Japanese rivalry or Asean disunity remains to be seen. But progress in East Asia has the unfortunate side effect of increasing the divide between East and South Asia. This is growing for three reasons. First, India’s failure to catalyze South Asian free trade or as yet play a major role in global trade. Second, Myanmar: It should be a bridge, literally and figuratively, between East and South Asia, but its dysfunctional huge system is a barrier. Third, though India-China trade has been rising fast, Indian worries over water resources are rising equally fast.

A new report by the Strategic Foresight Group, a Mumbai think-tank, suggests that climate change will bring 10-to-30 percent falls in river flows from the Himalayas over the next 40 years while demand increases and groundwater resources are depleted. In theory this should spur cooperation between the approximately 1.3 billion people who live in the river basins on either side of the Himalayas. But instead it is increasing suspicions in India and Bangladesh in particular that upstream countries, notably China, hold the keys to the river flows and will use them for strategic gain.

As Europe declines and the U.S. stagnates, Asia’s potential and its fault lines become more clearly defined.