Region – the end of secular depreciation

The TWD and JPY appreciated rapidly in the 1980s, but in the subsequent decades gave up those gains. Three macro dynamics were involved: deflation, which increased real interest rates and improved competitiveness; tech, which went from strength to strength in Taiwan but stalled in Japan; and compression of household incomes, a structural phenomenon in Taiwan, and a key ingredient of the current cyclical weakness in Japanese aggregate demand.

The consensus is the CNY is about to follow the TWD and JPY down. The same dynamics are present: deflation; tech, which looks much more like Taiwan in the 1990s than Japan; and household consumption, which along with property, is the big driver of China's weak demand.

We are sceptical that CNY depreciation is inevitable. In fact, we'd continue to argue that CNY strength is both possible, and for China, desirable. Because of deflation, the CNY is weakening in real terms even without the nominal depreciation that is widely expected. That depreciation is helping China's exports and boosting the external surplus, and China is too big to be able to repeat the ever-rising-surplus, ever-depreciating model of Taiwan. Finally, the CCP has an explicit aim of raising income per capita to rich-country levels by 2035, and prominent government economists recognise this won't be possible if the exchange rate depreciates.

We'd also argue that there are reasons to think that the secular weakness of both the TWD and JPY is ending. In Japan, the economy has good momentum going into 2024, while the labour market is already tight. That means upside risk for consumption, which in turn means some risk of a surprise from the BOJ. Similarly, for Taiwan, despite the export recession of 2023, the labour market has remained tight, and exports are now recovering.

The one economy that doesn't fit this framework is Korea, where structurally there hasn't been a large external surplus, and cyclically the economy doesn't look so strong.