Weaker export prospects as a result of a global economic slowdown have led some emerging market economies to weaken their currencies. Some economies have also come under "unnecessary" pressures on their currencies as financial market participants build up expectations that their currencies would depreciate.

About two weeks ago, there were also market rumours that Beijing was unhappy with the way the JPY was weakening, and revived the threat raised a few years ago during the depth of the Asian financial crisis -- that if the JPY weakens to 140 against the USD, Beijing would not rule out the possibility of devaluating the RMB. This created some nervousness in the market.

When one country depreciates relative to the rest of the world, one could argue that export competitiveness for that country is enhanced. But as the experience of the emerging market crisis in the late-90s showed, competitive devaluation (when a lot of economies depreciate against each other) serves no other purpose but only to aggravate the uncertainties in global financial markets. To the extent that rises in interest rates and fiscal restraints are necessary to stabilize investor sentiments, the thinking that countries should depreciate to gain competitiveness is not only wrong, but also damaging and counter productive.

Competitive devaluation is deflationary globally (rather than reflationary as a depreciation in one country tries to achieve). This is not what a slowing world economy needs at this juncture. Excessive pessimism on Asia was counter-balanced by irrational exuberance in the US during the late-90s. Now that the US is slowing, what east Asia should do is certainly NOT to engage in another round of meaningless competitive devaluation. Nobody could export out of their trouble if everybody try to do so.

Many Asian economies are doing what they should be doing -- to stimulate domestic demand through deficit fiscal spending (with the notable exception of Hong Kong which continues to place a lot of emphasis on "fiscal prudence" -- wrongly in my view and unfortunate because of the constraints imposed by the Basic Law). Any speculative pressure on the exchange rates, driven by misconceptions about the need to promote exports, would only lead to higher interest rates than necessary, and is undesirable.

In fact, most economies in east Asia continue to have trade surpluses. But the mere prospect of such surpluses shrinking are sufficient to drive many government officials and financial market participants to think that the currencies concerned should depreciate.

Logically, you could not have every economy in world having current account surpluses. When the US was willing to sustain a large current account deficit, the emerging markets (east Asia in particular) could build up large current account surplus. But globally, this is not a healthy nor a sustainable situation.

Interestingly, the need to build up large current account surpluses is justified on the ground that the emerging market governments need more FX reserves to help defend their currencies. But in contrast, the US, with the largest currency account deficit (and widely seen to be unsustainable), has one of the world's strongest currencies.

Many economies in east Asia have massive FX reserves. These are valuable financial resources of the economies concerned which could have been used to promote economic development. But the realities of the financial markets are that these reserves are invested instead in US or other OECD government treasury securities, or placed on deposit with OECD banks in New York or London.

Furthermore, more resources held by the public sector represents less resources held by the private sector in the economies concerned. This means that the private sector has to borrow more (relative to the scenario when the public sector holds less financial resources). Typically, private sector borrowers have to pay more for their borrowings than their governments. For many east Asian economies, the instability and uncertainties of the financial markets and on the currency impose therefore quite substantial costs on the country as a whole.

But the problems with the global foreign exchange rate system are not new. They date back at least to the days when the Bretton Woods system was designed. Talks of the need to reform the global financial architecture ever since the emerging markets crisis of the late-90s have also largely subsided.

But governments in east Asia are not stupid. In the absence of global and comprehensive solutions, they look for partial answers. A friend of mine in the Hong Kong Monetary Authority told me that in various gatherings of the governments and central banks in the region, many Asian governments have told their Japanese counterparts that a weak Yen could have a substantial destabilizing impact on the currencies in east Asia, and that competitive devaluation is not going to help anybody. I was told that the Japanese authorities have certainly got the message.

K.C. Kwok