The roller-coaster ride for Asian currencies, which saw only the yen and yuan post significant gains for the year against the U.S. dollar, is set to continue in 2012.
While Japan actively sought to stem the yen's rise -- drawing U.S. criticism last week -- China intervened to ensure the yuan ended the year at a new high. Both currencies appreciated roughly 5 percent in 2011 against the dollar.
The opposite approaches illustrate a dilemma facing Asian policymakers as they try to smooth out foreign exchange rate volatility, which shows no sign of abating in the new year. If the currency is too strong, exports get more expensive. Too weak, and imported inflation spikes and domestic buying power fades.
Singapore and South Korea provide two examples of how inflation can stay surprisingly high, even as declining global demand curbs exports and saps growth. Both the Singapore dollar and the won slipped against the greenback in 2011.
For Japan, which has been battling deflationary forces for two decades, rising prices would be a welcome change. Three times in 2011, Tokyo intervened in the currency market to try to weaken the yen, once with the help of Group of 7 nations after the March earthquake and tsunami, and twice unilaterally.
It was the solo moves that drew Washington's ire. The Treasury pointed out in its December 27 report to Congress on world currencies that the United States "did not support these interventions," and said Japan would be better served by taking steps to increase the dynamism of its domestic economy.
"The United States is saying, our recovery is dependent on the (U.S.) dollar not becoming too strong," said Yukon Huang, an economist with the Washington-based Carnegie Endowment for International Peace.
"It's worried that there will be a global move for people to depreciate" their currencies, he said.
The twice-yearly currency report was mandated by Congress in 1988, when the trade imbalance with Japan was the main concern. More recently, it has become a source of friction with China.
Even the critique of Japan in the latest report may have been intended as a message for Beijing.
"The criticism (of Japan) is accurate but it's 20 years old and resuscitated as cover," said Derek Scissors, a research fellow at the conservative Heritage Foundation in Washington.
"It's so they don't appear to be picking on China."
If Treasury determines a country is manipulating its currency to gain a trade advantage, it can call in the International Monetary Fund to press for a realignment.
Some U.S. lawmakers, businesses and unions want Washington to label China a manipulator, but Treasury declined to do so yet again in its latest report. It did, however, mention China twice as many times as it referred to Japan.
While there may be politics at play in the currency report, a closer look at trading in China's yuan suggests Beijing may have earned its reprieve this time.
ENDING ON A HIGH NOTE
The United States has long argued that a stronger yuan is in China's best interest because it can help ease inflationary pressures and lift domestic spending power.
China's central bank keeps the currency on a tight leash by setting a daily midpoint and then allowing only a one-half percent move on either side.
In the first half of December, the yuan traded limit-down nearly every day, partly due to demand for dollars but also reflecting increasing concern that China's economy will falter as export demand slows and its housing market declines.
The People's Bank of China intervened on December 16 and again on December 30 to prop up the yuan, traders told Reuters. That left the yuan up 4.7 percent against the U.S. dollar in 2011, even though China's exports have cooled over the past six months and will probably slow even more in 2012.
The yuan's performance makes it more difficult for the United States to claim China is intentionally weakening its currency to gain a trade advantage.
"The argument gets weaker when China is moving toward a smaller trade surplus," said Carnegie's Huang, who is also a former World Bank country director for China.
Why would China favor a stronger currency now? It helps to defuse political tension with the United States and discourage traders from assuming the yuan is a safe one-way bet, and it can also neutralize imported inflation.
China's annual inflation rate has dropped dramatically since it hit a three-year peak of 6.5 percent in July, but it is still above the government's target of 4 percent.
With oil trading around $100 per barrel even though the world economy looks shaky, it would not take much of a shock to push prices back up to the $115 level seen in May, which threatened to choke off the global recovery.
This complicates currency policy across Asia.
Aside from the yuan and yen, most Asian currencies weakened in 2011. South Korea, Indonesia and India stepped in to try to cap currency volatility, but countries across the region seemed content to allow a gradual decline.
That may change in 2012.
In Singapore, considered a regional bellwether because the city state is so closely tied to the global economy, annual inflation spiked unexpectedly to 5.7 percent in November.
Trade-dependent Singapore uses the exchange rate as its primary policy tool, and has slowed the pace of appreciation to try to support growth. But that leaves it vulnerable to imported inflation.
In South Korea, a measure of factory activity fell to its lowest in nearly three years in December, figures on Monday showed, yet its inflation rate came in above the central bank's target. The Bank of Korea said last week that fighting inflation would remain the top policy priority in 2012.
This suggests Seoul may rethink the wisdom of allowing its won to weaken.
"We believe the government's tolerance for a weak won is waning," Barclays economist Wai Ho Leong wrote in a note to clients on December 30.
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