By JC Collins
At times I become as giddy as a young school girl when researching and making connections across the broad spectrum of macroeconomics and geopolitical trade agreements. The study of the global imbalances caused by using one domestic currency (USD) as the international reserve asset is one of these areas. Another is the study of Vietnam and its currency, the dong.
Jokes about the dong aside (and there are plenty), it has become an increasingly series subject with massive ramifications for regional economic growth in Southeast Asia. This growth and potential appreciation of the Vietnamese currency is intertwined with the efforts to rebalance the global economy, as I will explain below.
Over the last year and half I have written a few pieces on the economic performance of Vietnam in the post war years, and the intent of the State Bank of Vietnam to revalue the domestic currency (dong or VND), as the world monetary system shifts from the unipolar USD framework to the multilateral SDR framework.
Vietnam, as a member of ASEAN, has signed on to the AEC trade agreement which will come into effect on January 1, 2016. The AEC was thoroughly covered in the post When Will China End the Dollar Peg. I would encourage all readers to revisit that specific piece and make the obvious connections which will be presented here.
One of the most challenging aspects of the current unipolar (USD) monetary framework are the systemic imbalances which it creates. This is nowhere more noticeable than in the trade deficit, or balance of payments deficit, which the United States has developed. This imbalance continues to grow year after year, and because the dollar is the primary reserve currency, and used as an anchor and peg for other currencies, it forces other countries to continuously depreciate their own domestic currencies as a method of maintaining a peg to the dollar. This arrangement is an indirect method of the United States exporting its own domestic inflation overseas.
This structural flaw in the monetary system has increased the risk to global growth by expanding the imbalances themselves and corrupting the flow of capital which is associated with those imbalances. The world is implementing a solution to this problem by engineering a multilateral architecture which will revolve around the SDR of the International Monetary Fund as the primary reserve asset used in global commerce.
One segment of this multilateral shift has to do with using exchange rates as a method of correcting the imbalances. It has been determined that appreciating the domestic currencies of trade surplus countries is a viable rebalancing strategy. This is likely what is behind so much of the “global currency reset” talk and conspiracy which has built up online over the last 5 years. It is not a coincidence that talk of this sort began at the same time as 2010 IMF Quota and Governance Reforms and announcements from China on moving away from the USD towards a supra-sovereign (non-domestic) asset, such as the SDR, and discussions around the sovereign debts of historical bonds.
Trade surplus countries are those with a positive balance of trade, such as China, where exports exceed imports, leading to a net inflow of domestic currency from foreign markets. This is obviously opposite from trade deficit countries, such as the US, where imports exceed exports, leading to a net outflow of domestic currency into foreign markets.
That fact that the USD is the primary reserve asset has compounded the problem of this net outflow of domestic currency on countries like Vietnam, who have had to depreciate their own currency over the last 4 decades in order to maintain a peg with the dollar and build a trade exporting economy.
There are a few different ways of viewing trade exporting countries. One is by a percentage of Gross Domestic Product, and the other is strictly by volume, or dollar amount.
When measured as a percentage of GDP, the following countries are all considered net trade exporters:
• Saudi Arabia at 14.11% of GDP
• Germany at 7.45% of GDP
• Vietnam at 5.42% of GDP
• Russia at 3.09% of GDP
• China at 2.02% of GDP
As opposed to the United States at -2.36% of GDP.
There are many more and this is only a short list for purposes of this article.
When we view trade exporting data through straight volume in dollars we find that China is one of the largest, along with Saudi Arabia (because of petroleum products), and Vietnam actually falls to a net importer. But that is quickly changing.
In March of 2015, Vietnam’s trade deficit was $1.391B and in April of 2015 it had already reduced to $600 million. This is a dramatic reduction in trade deficit in only one month. Though the trade deficit of Vietnam has been up and down for many years, this type of trade deficit decrease is symptomatic of the multilateral changes which are taking place in the world.
The American Chamber of Commerce predicts that Vietnam will soon become the largest Southeast Asian trade partner to the United States. The country, which is strategically located to serve as an effective export hub to reach other ASEAN markets, is emerging as a leader in low-cost manufacturing and sourcing of raw materials.
The labor costs in Vietnam are 50% of those in China, 40% of Thailand, and 40% of the Philippines, and its domestic workforce is growing by 1.5 million per year.
When the AEC comes into effect on January 1, 2016, Vietnam will see an increase in exports as its goods become accessible to the world’s largest markets. The AEC ensures that there will be few tariffs and restrictions on Vietnamese exports. This, along with changes to domestic regulations making Vietnam more investor friendly, in terms of trade, will allow the country to become one of the wealthiest in Southeast Asia.
As Vietnam becomes a sustainable trade exporting country, or trade surplus economy, the exchange rate of its currency will be adjusted to facilitate the process of rebalancing the monetary framework internationally. In effect, reversing the USD inflation which has been built up in the domestic economy and currency of Vietnam.
As with all things there will be some challenges with this as well.
Though the appreciation of the domestic currencies of emerging economies is a viable strategy of rebalancing, it will have to be implemented parallel with the structural changes as designed in the multilateral framework.
The multilateral transition, and using the SDR as the primary reserve asset, will help reduce the effects of slowing domestic growth as surplus exporters adjust the exchange rates of their currencies. A peg to the SDR, as opposed to the domestic USD currency, will facilitate the transition for many economies, while ensuring a minimal amount of export loss.
One other method of addressing this issue is to allow economies to gradually shift from an export oriented model to a model with domestic sources of growth. This was also covered in the post The Redback Revolution, as China plans to move from the trade export based model to a trade services model.
One remaining issue with appreciating the domestic currency of Vietnam is accounting for the large money supply which has accumulated as a response to the USD forced imbalances. Based on the Open Market Operational functions of central banks, in this case the State Bank of Vietnam, the SBV can contract or expand the money supply by increasing or reducing the purchases of government securities, or bonds.
The SBV is unable to contract the money supply because that would mean purchasing less government bonds and ending the managed peg to the USD. The multilateral framework is not yet ready to support such a move by Vietnam, but could be by Jan 1, 2016, which is when both the AEC trade agreement and new SDR composition, which will include the Chinese currency, will come into effect.
The State Bank of Vietnam, or any other central banks, have the ability to bring money in and out of existence. As such, a method of reducing the money supply, once the VND ends the peg to the USD, could simply entail purchasing additional government bonds with the existing money supply, as opposed to creating new money supply. This would take money out of circulation.
The only thing preventing the SBV from contracting its money supply and appreciating its currency, is the managed peg to the dollar, which is increasing exactly the type of imbalances which have placed Vietnam in the situation to have to address the imbalances in the first place.
During this multilateral transition we will experience many forms of adjustment, some of which may not make sense initially, but will when contrasted against the larger process. Examples of this are the ending of the Swiss franc peg, and the recent move by Greece to make a debt payment to the IMF with SDR, which is in essence paying a debt to the IMF with the actual debt itself.
In such a crazy world, anything and everything is possible, including the appreciation of not just the Chinese renminbi, but also the Vietnamese dong. Especially if the VND gets pegged to the RMB, and the RMB to the SDR. – JC