The Return to Soft Dollar Pegging in East AsiaMitigating Conflicted
Virtue
Ronald McKinnon and Gunther Schnabl Stanford University Tübingen University
October 2004
The Exchange Rate Debate in the 1990sBefore 1997, East Asian countries, except for Japan, “softly” pegged
their exchange rates to the U.S. dollar.
1997-98 Crisis: Thailand, Indonesia, Philippines, Korea, and Malaysia are attacked and devalue—with bankruptcies and economic downturns spreading contagiously.
The IMF blames the soft pegging for encouraging over borrowing and current account deficits leading unsustainable dollar and yen debts. It warns against any return to dollar pegging.
Williamson (2000), Kawai (2002), Ogawa and Ito (2002)—suggest weighting the Japanese yen more heavily in the currency baskets of the smaller East Asian economies in the face of wide fluctuations in the yen/dollar rate.
The Debate In the New MillenniumBy 2004, the East Asian “crisis” and non crisis economies had returned
to soft dollar pegging. China and Hong Kong retained hard pegs through the crisis, and Malaysia pegged in Sept 1998 at 3.8 ringgit per dollar. Even the yen/dollar rate is more stable.
But now all East Asian countries run large current account surpluses—even with net inflows of FDI (China). Only massive foreign official interventions kept their exchange rates from appreciating in 2003 and early 2004
Influential articles by Dooley, Folkerts-Landau, and Garber (2003)-(2004) argue that East Asian countries on the dollar’s “periphery” are deliberately undervaluing their currencies to stimulate exports to the U.S. at the “center” to promote development.
Intensified pressure from the IMF, the G-7, and the U.S. Treasury, for China to appreciate: “There should be more flexible currencies, not only for China but the whole of Asia” Rodrigo de Rato, IMF Managing Director, 29 Sept 2004 at IMF-World Bank Meetings in Washington.
This Paper and McKinnon Book (2005) The Case for Asian Dollar Pegs
East Asian economies Have sufficient fiscal and monetary control to
target exchange rates, but have more difficulty targeting domestic inflation independently.
Are becoming highly integrated economically with more than 50% of trade with each other. They need stable cross rates of exchange.
Debtor countries have “original sin” and creditors have “conflicted virtue” making foreign exchange risks more difficult to hedge.
The Rise of Intra Regional Trade in East Asia, 1980-2002 (share of total exports)
Exports
0
10
20
30
40
50
Intra East Asia United States Rest of the World
Perc
enta
ge
1980
1990
2002
East Asia: China, Hong Kong, Indonesia, Japan, Korea, Malaysia, Philippines, Singapore, Taiwan, and Thailand
The Rise of Intra Regional Trade in East Asia, 1980-2002 (share of total imports)
Imports
0
10
20
30
40
50
60
Intra East Asia United States Rest of the World
Pe
rce
nta
ge
1980
1990
2002
East Asia: China, Hong Kong, Indonesia, Japan, Korea, Malaysia, Philippines, Singapore, Taiwan, and Thailand
Figure 1: East Asian Exchange Rate Pegs against the Dollar, 1980:01-2004:04 (Monthly)
Taiwan DollarSingapore Dollar
Hong Kong DollarChinese Yuan
0
100
200
300
400
500
600
700
800
1980.011983.011986.011989.011992.011995.011998.012001.012004.01
0
100
200
300
400
500
600
700
800
0
100
200
300
400
500
600
700
800
1980.011983.011986.011989.011992.011995.011998.012001.012004.01
0
100
200
300
400
500
600
700
800
1980.011983.011986.011989.011992.011995.011998.012001.012004.01
Figure 1 (Continued) Crisis Economies, 1980:01-2004:04 (Monthly)
Thai BahtPhilippine Peso
Malaysian RinggitKorean WonIndonesian Rupiah
0
500
1000
1500
2000
2500
1980.011983.011986.011989.011992.011995.011998.012001.012004.010
100
200
300
400
500
600
700
800
1980.011983.011986.011989.011992.011995.011998.012001.012004.01
0
100
200
300
400
500
600
700
800
1980.011983.011986.011989.011992.011995.011998.012001.012004.01
0
100
200
300
400
500
600
700
800
1980.011983.011986.011989.011992.011995.011998.012001.012004.010
100
200
300
400
500
600
700
800
1980.011983.011986.011989.011992.011995.011998.012001.012004.01
Frankel and Wei Regression (1994)
Problem: For any one East Asian currency other than Japan, how do you measure the weight of each major currency—the dollar, yen, or euro—in its currency “basket”?
Answer: Choose an outside currency as numeraire, e.g., the Swiss Franc, to measure all exchange rates in the above regression.
trancMarkSwissfancYenSwissfrsfrancDollarSwis
ssfrancurrencySwiEastAsianc
ueee
e
ttt
t
4321
Figure 2: Dollar’s Weight in East Asian Currency Baskets, 130-Trading-Day Rolling Regressions, 1990:01-2004:05 (Daily)
Taiwan DollarSingapore Dollar
Hong Kong DollarChinese Yuan
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
01.01.1990 01.01.1993 01.01.1996 01.01.1999 01.01.2002
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
01.01.1990 01.01.1993 01.01.1996 01.01.1999 01.01.2002
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
01.01.1990 01.01.1993 01.01.1996 01.01.1999 01.01.20020.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
01.01.1990 01.01.1993 01.01.1996 01.01.1999 01.01.2002
Figure 2 (Continued), Dollar’s Weight in East Asian Currency Baskets Crisis Economy, 1990:01-2004:05 (Daily)
Thai BahtPhilippine Peso
Malaysian RinggitKorean WonIndonesian Rupiah
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
01.01.1990 01.01.1993 01.01.1996 01.01.1999 01.01.2002
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
01.01.1990 01.01.1993 01.01.1996 01.01.1999 01.01.20020.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
01.01.1990 01.01.1993 01.01.1996 01.01.1999 01.01.2002
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
01.01.1990 01.01.1993 01.01.1996 01.01.1999 01.01.2002
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
01.01.1990 01.01.1993 01.01.1996 01.01.1999 01.01.2002
Figure 3: Exchange Rate Volatility against the US Dollar of Selected Crisis and Non-Crisis Currencies, 1990:01-2004:05 (Daily)
-8%
-6%
-4%
-2%
0%
2%
4%
6%
8%
01.01.1990 01.01.1993 01.01.1996 01.01.1999 01.01.2002
Japanese YenPhilippine PesoMalaysian Ringgit
Thai BahtHong Kong DollarChinese Yuan
-8%
-6%
-4%
-2%
0%
2%
4%
6%
8%
01.01.1990 01.01.1993 01.01.1996 01.01.1999 01.01.2002
-8%
-6%
-4%
-2%
0%
2%
4%
6%
8%
01.01.1990 01.01.1993 01.01.1996 01.01.1999 01.01.2002
-8%
-6%
-4%
-2%
0%
2%
4%
6%
8%
01.01.1990 01.01.1993 01.01.1996 01.01.1999 01.01.2002-8%
-6%
-4%
-2%
0%
2%
4%
6%
8%
01.01.1990 01.01.1993 01.01.1996 01.01.1999 01.01.2002-8%
-6%
-4%
-2%
0%
2%
4%
6%
8%
01.01.1990 01.01.1993 01.01.1996 01.01.1999 01.01.2002
Figure 3 (Continued), Exchange Rate Volatility against the US Dollar, 1990:01-2004:05 (Daily)
Swiss FrancNew Taiwan DollarSingapore Dollar
Euro (German Mark)Korean WonIndonesian Rupiah
-8%
-6%
-4%
-2%
0%
2%
4%
6%
8%
01.01.1990 01.01.1993 01.01.1996 01.01.1999 01.01.2002
-8%
-6%
-4%
-2%
0%
2%
4%
6%
8%
01.01.1990 01.01.1993 01.01.1996 01.01.1999 01.01.2002
-8%
-6%
-4%
-2%
0%
2%
4%
6%
8%
01.01.1990 01.01.1993 01.01.1996 01.01.1999 01.01.2002
-8%
-6%
-4%
-2%
0%
2%
4%
6%
8%
01.01.1990 01.01.1993 01.01.1996 01.01.1999 01.01.2002
-8%
-6%
-4%
-2%
0%
2%
4%
6%
8%
01.01.1990 01.01.1993 01.01.1996 01.01.1999 01.01.2002-8%
-6%
-4%
-2%
0%
2%
4%
6%
8%
01.01.1990 01.01.1993 01.01.1996 01.01.1999 01.01.2002
Table 1: Standard Deviations of Daily Exchange Rate Fluctuations against the Dollar
Pre-crisis Crisis Post-crisis 2003/2004
Chinese Yuan 0.03 0.01 0.00 0.00
Hong Kong Dollar 0.02 0.03 0.03 0.05
Indonesian Rupiah 0.17 4.43 1.11 0.43
Korean Won 0.22 2.35 0.43 0.43
Malaysian Ringgit 0.25 1.53 0.00 0.00
Philippine Peso 0.37 1.31 0.51 0.25
Singapore Dollar 0.20 0.75 0.27 0.29
New Taiwan Dollar 0.19 0.50 0.21 0.20
Thai Baht 0.21 1.55 0.38 0.27
Japanese Yen 0.67 1.00 0.64 0.57
Euro (Deutsche Mark) 0.60 0.58 0.64 0.64
Swiss Franc 0.69 0.66 0.66 0.70
Data source: Datastream. Percent changes. Pre-crisis = 02/01/94 – 05/30/97, crisis = 06/01/97 – 12/31/98, post-crisis = 01/01/99 – 05/17/04, 2003/2004 = 01/01/03 – 05/17/04.
Table 2: Standard Deviations of Monthly Exchange Rate Fluctuations against the Dollar
Data source: IMF: IFS.
Pre-crisis Crisis Post-crisis
Chinese Yuan 0.25 0.03 0.00
Hong Kong Dollar 0.08 0.07 0.11
Indonesian Rupiah 0.26 26.54 5.16
Korean Won 1.01 11.53 1.92
Malaysian Ringgit 1.06 6.69 0.00
Philippine Peso 1.19 5.25 1.67
Singapore Dollar 0.76 2.88 1.18
New Taiwan Dollar 1.01 2.63 1.35
Thai Baht 0.43 8.88 1.60
Japanese Yen 3.66 3.64 2.39
Euro (Deutsche Mark) 2.20 2.33 2.58
Swiss Franc 2.62 2.60 2.54
Figure 4: Exchange Rate Changes against the US dollar 1999:01-2001:12
0.00% 5.00% 10.00% 15.00% 20.00% 25.00% 30.00% 35.00% 40.00%
Chinese Yuan
Hong Kong Dollar
Indonesian Rupiah
Korean Won
Malaysian Ringgit
Philippine Peso
Singapore Dollar
New Taiwan Dollar
Thai Baht
Japanese Yen
Euro
Swiss Franc
depreciation
Data source: IMF: IFS.
Figure 5: Exchange Rate Changes against the US dollar 2002:01-2004:04-30.00% -25.00% -20.00% -15.00% -10.00% -5.00% 0.00% 5.00% 10.00% 15.00%
Chinese Yuan
Hong Kong Dollar
Indonesian Rupiah
Korean Won
Malaysian Ringgit
Philippine Peso
Singapore Dollar
New Taiwan Dollar
Thai Baht
Japanese Yen
Euro
Swiss Franc
appreciation
Data source: IMF: IFS.
Figure 6: Official Foreign Exchange Reserves of Crisis and Non-Crisis Countries in Millions of Dollars,
1980:01-2004:04 (Monthly)
GermanyPhilippinesMalaysia
ThailandHong Kong China
0
40000
80000
120000
160000
200000
240000
280000
1980:01 1984:01 1988:01 1992:01 1996:01 2000:010
20000
40000
60000
80000
100000
120000
1980:01 1984:01 1988:01 1992:01 1996:01 2000:01
0
5000
10000
15000
20000
25000
30000
35000
40000
1980:01 1984:01 1988:01 1992:01 1996:01 2000:01
0
5000
10000
15000
20000
25000
30000
35000
40000
1980:01 1984:01 1988:01 1992:01 1996:01 2000:01
0
2000
4000
6000
8000
10000
12000
14000
16000
1980:01 1984:01 1988:01 1992:01 1996:01 2000:01
0
20000
40000
60000
80000
100000
120000
1980:01 1984:01 1988:01 1992:01 1996:01 2000:01
Figure 6 (Continued), Official Foreign Exchange Reserves, 1980:01-2004:04 (Monthly)
USTaiwan Singapore
JapanKoreaIndonesia
0
4000
8000
12000
16000
20000
24000
28000
32000
1980:01 1984:01 1988:01 1992:01 1996:01 2000:01
0100002000030000400005000060000700008000090000
100000110000120000130000
1980:01 1984:01 1988:01 1992:01 1996:01 2000:01
0
50000
100000
150000
200000
250000
300000
350000
400000
450000
500000
1980:01 1984:01 1988:01 1992:01 1996:01 2000:01
0
10000
20000
30000
40000
50000
60000
70000
80000
90000
1980:01 1984:01 1988:01 1992:01 1996:01 2000:01
0
20000
40000
60000
80000
100000
120000
140000
160000
180000
1980:01 1984:01 1988:01 1992:01 1996:01 2000:01
0
10000
20000
30000
40000
50000
60000
1980:01 1984:01 1988:01 1992:01 1996:01 2000:01
Dollar dominance in East Asia
Original sin Underdeveloped domestic bond market or in some cases
developed domestic bond market (India) Debtors cannot borrow in own currency nor can they hedge
their net dollar indebtedness. Currency mismatch and maturity mismatch.
[Eichengreen and Hausmann 1999, Hausmann and Panizza 2003]
Conflicted virtue Creditors cannot lend in their own currencies nor can they
hedge their net dollar assets. Currency mismatch but no necessary maturity mismatch
[McKinnon and Schnabl 2004, McKinnon 2005]
Conflicted virtue
High-saving countries lend to foreigners in the form of current account surpluses. However, as the stock of dollar claims cumulates: Foreigners start complaining that the country’s ongoing
flow of trade surpluses is unfair and the result of having an undervalued currency.
Domestic holders of dollar assets worry more about a self-sustaining run into the domestic currency forcing an appreciation.
Conflicted virtue: To appreciate or not to appreciate
As runs into the domestic currency out of dollars begin, the government is “conflicted” because (repetitive) appreciation could set in train serious deflation ending with a zero interest liquidity trap (Japan)
But failure to appreciate could elicit trade sanctions from foreigners.
A “free” float becomes an indefinite upward spiral
The story of Japan (I)
There were repetitive appreciations of yen from 1970s to mid-’90s under mercantile pressure from trade partners―particularly the United States, but trade surpluses continued to cumulate.
Reason: Exchange rate changes only determine domestic
inflation or deflation, not trade balance. The simple-minded elasticities approach is invalid in financially open economies. [McKinnon and Ohno 1997]
Do exchange rate changes necessarily bring BoP balance?
Elasticity model BoP balance through current
account changes if Marshall-Lerner condition holds.
McKinnon and Ohno in Dollar and Yen (1997): Inflationary/deflationary pressure
only. Indeterminate CA effect in the
short term because of domestic absorption effect.
The story of Japan (II)
Negative risk premium [Goyal and McKinnon 2003]
To maintain portfolio balance, Japanese financial institutions demand a higher return on dollars (which is riskier given the volatility in exchange rate).
The internationally determined dollar asset return thus pushes down the yen interest rate. It finally forced Japan into the the zero interest liquidity trap by the end of 1996.
Is China like Japan? China has a big advantage over Japan:
The RMB exchange rate has been and can be more credibly maintained at the current level without disturbing domestic price level.
And a disadvantage: China’s net FDI inflows are much larger than
Japan’s. FDI can be seen as illiquid liabilities but imposes liquid dollar claims.
Table 3: East Asian Current Accounts in Comparison to the U.S., 1990-2003
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
Percent of GDP
Japan 1.5 2.0 3.0 3.0 2.7 2.1 1.4 2.3 3.0 2.6 2.5 2.1 2.8 3.2
Singapore 8.5 11.3 11.9 7.2 16.2 17.7 15.2 15.6 22.6 18.6 14.5 19.0 21.5 30.9
Taiwan 7.0 7.1 4.1 3.1 2.7 2.1 3.9 2.4 1.3 2.8 2.9 6.4 9.1 10.0
Indonesia -2.6 -3.3 -2.0 -1.3 -1.6 -3.2 -3.4 -2.3 4.3 4.1 5.3 4.9 4.5 3.9
Korea -0.8 -2.8 -1.3 0.3 -1.0 -1.7 -4.4 -1.7 12.7 6.0 2.7 1.9 1.3 2.0
Malaysia -2.0 -8.5 -3.7 -4.5 -6.1 -9.7 -4.4 -5.9 13.2 15.9 9.4 8.3 7.6 11.1
Philippines -6.1 -2.3 -1.9 -5.6 -4.6 -2.7 -4.8 -5.3 2.4 9.5 8.2 1.8 5.4 2.1
Thailand -8.5 -7.7 -5.7 -5.1 -5.6 -8.1 -8.1 -2.0 12.7 10.1 7.6 5.4 6.1 5.6
China 3.1 3.3 1.4 0.0 1.3 0.2 0.9 4.1 3.3 2.1 1.9 1.5 2.9 2.1
Hong Kong 1.5 6.4 4.3 6.1 8.5 11.0
United States -1.4 0.1 -0.8 -1.2 -1.7 -1.4 -1.5 -1.5 -2.3 -3.1 -4.2 -3.9 -4.6 -4.9
Billions of US Dollars
Total East Asia 54.5 73.8 117.5 117.8 132.9 93.8 44.2 129.4 244.5 231.7 213.7 179.1 238.9 255.2
Total US -79.0 3.7 -48.0 -82.0-
117.7-
105.2-
117.2-
127.7-
204.7-
290.9-
411.5-
393.7-
480.9-
541.8
Data source: IMF: IFS.
Figure 7: International Investment Position of Japan (Billions of Dollars)
-200
0
200
400
600
800
1000
1200
1400
1600
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002
billi
ons
of d
olla
rs
total
public
private
Source: Japan: Ministry of Finance.
Figure 8: Interest Rates in the US and Japan, Long-Term: 10-Year US Treasuries and JGBs, 1980-2004
0
2
4
6
8
10
12
14
16
1980M1 1983M1 1986M1 1989M1 1992M1 1995M1 1998M1 2001M1 2004M1
perc
ent p
er a
nnum
Japan
US
Figure 8: Interest Rates in the US and Japan, Short-Term: Money Market Rates , 1980-2004
0
2
4
6
8
10
12
14
16
18
20
1980M1 1983M1 1986M1 1989M1 1992M1 1995M1 1998M1 2001M1 2004M1
perc
ent p
er a
nnum
Japan (call money rate)
US (federal funds rate)
Implications for Interest Rates: The Negative Risk Premium To sustain the interest differential between yen and dollar
assets, consider an augmented interest parity relationship:
i = i* + se + where i is the (endogenously determined) Japanese long-
term nominal interest rate, i* is the (exogenously given) US long-term nominal interest rate, s is the yen price of one dollar, se is expected depreciation of the yen, and is the risk premium on yen assets.
From the 70s to the mid 90s, the interest differential, i – i*, was driven primarily by the negative se term when the erratically appreciating yen peaked out in April 1995. Since the mid-90s, se 0 and the interest differential has been driven primarily by the term, which is also negative (Goyal and McKinnon 2003).
Figure 9: Money Market Interest Rates 1990:01-2004:01 (Monthly)
TaiwanSingapore
Hong Kong China (Bank Rate)
0
2
4
6
8
10
12
1990M1 1992M1 1994M1 1996M1 1998M1 2000M1 2002M1 2004M1
China
United States
0
2
4
6
8
10
12
14
16
1990M1 1992M1 1994M1 1996M1 1998M1 2000M1 2002M1 2004M1
Hong Kong
United States
0
1
2
3
4
5
6
7
8
9
10
1990M1 1992M1 1994M1 1996M1 1998M1 2000M1 2002M1 2004M1
Singapore
United States
0
2
4
6
8
10
12
14
1990M1 1992M1 1994M1 1996M1 1998M1 2000M1 2002M1 2004M1
Taiwan
United States
Figure 9 (Continued), Money Market Interest Rates 1990:01-2004:01 (Monthly)
ThailandPhilippines
MalaysiaKoreaIndonesia
0
10
20
30
40
50
60
70
80
90
1990M1 1992M1 1994M1 1996M1 1998M1 2000M1 2002M1 2004M1
Indonesia
Singapore
0
5
10
15
20
25
1990M1 1992M1 1994M1 1996M1 1998M1 2000M1 2002M1 2004M1
Korea
United States
0
2
4
6
8
10
12
1990M1 1992M1 1994M1 1996M1 1998M1 2000M1 2002M1 2004M1
Malaysia
United States
0
5
10
15
20
25
30
1990M1 1992M1 1994M1 1996M1 1998M1 2000M1 2002M1 2004M1
Philippines
United States
0
5
10
15
20
25
1990M1 1992M1 1994M1 1996M1 1998M1 2000M1 2002M1 2004M1
Thailand
United States
Interest Differentials, Portfolio Balance, and the Impossibility Free Floating As dollar claims accumulate, a sufficiently large
interest differential to induce private portfolio holdings of dollars becomes unsustainable—as in Japan when yen interest rates approach zero.
The problem worsens when US interest rates are unusually low, as in 2003-04.
Then, increasing official foreign exchange reserves become the dominant mode of financing Asian current account surpluses.
And the private unwillingness to hold dollars makes a free float impossible.
Table 4: East Asian Current Accounts (CA) and Changes in Foreign Reserves (RC) Billions of Dollars 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
Japan CA 44 68 113 132 130 111 66 97 119 115 120 88 112 136
RC -9 -8 0 27 26 57 35 1 -5 74 70 41 64 201
Singapore CA 3 5 6 4 11 15 14 15 19 15 13 16 19 28
RC 7 6 6 8 10 10 8 -6 4 2 3 -5 7 14
Taiwan CA 11 12 9 7 7 5 11 7 3 8 9 18 26 29
RC -1 10 0 1 9 -2 -2 -5 7 16 1 15 39 45
Indonesia CA -3 -4 -3 -2 -3 -6 -8 -5 4 6 8 7 8 8
RC 2 2 1 1 1 1 5 -2 6 4 2 -1 4 4
Korea CA -2 -8 -4 1 -4 -9 -23 -8 40 24 12 8 6 12
RC -1 -1 3 3 5 7 1 -14 32 22 22 7 18 34
Malaysia CA -1 -4 -2 -3 -5 -9 -4 -6 10 13 8 7 7 11
RC 2 1 6 10 -2 -2 3 -6 5 5 -1 1 4 10
Philippines CA -3 -1 -1 -3 -3 -2 -4 -4 2 7 6 1 4 2
RC -1 2 1 0 1 0 4 -3 2 4 0 0 0 0
Thailand CA -7 -8 -6 -6 -8 -14 -15 -3 14 12 9 6 8 8
RC 4 4 3 4 5 7 2 -12 3 5 -2 0 6 3
China CA 12 13 6 -12 7 2 7 37 31 21 21 17 35 31
RC 12 14 -23 2 30 22 31 35 5 10 11 47 74 117
HK SAR CA 3 10 7 10 14 17
RC 4 6 8 6 6 8 29 -3 7 11 4 1 6
East Asia CA 56 74 116 125 136 93 45 133 241 230 217 182 248 255
RC 16 35 3 64 92 107 95 19 56 148 117 109 216 434
Figure 10: US and cumulative East Asian Current Accounts (Billions of US Dollars)
-600
-500
-400
-300
-200
-100
0
100
200
300
400
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002
bill
ions
of
doll
ars
US
East Asia
Data source: IMF: IFS.
Revived Bretton Woods: EA Exchange Rates are deliberately undervalued to support an export drive into American markets.
Exports are desired to promote “development”, particularly in manufacturing.
Asian governments are willing to pay the cost of investing in very low yield US Treasuries, and to accept American FDI with high profit repatriation.
US gets finance for its fiscal deficits Despite adjustment costs in US manufacturing,
the ongoing current-account deficit is sustainable
I. The Dollar Standard and East Asia’s Trade Surplus: The DFG Approach
II. The Dollar Standard and East Asia’s Trade Surplus: The MCS Approach With the dollar as international money, the
efficiency of world trade and payments increases. If the U.S. price level is stable, peripheral
countries will peg to the dollar to anchor their own price levels—not to “undervalue” their currencies, which would be inflationary.
Massive interventions by East Asian central banks to prevent exchange appreciation incidentally extend the US credit line with the rest of the world, softening borrowing constraints on US households and on the Federal Government.
The upshot has been falling US saving and large current account deficits for more than 20 years.
Restraining American Deficits? An attack on the dollar is unlikely because US debts are
denominated in its own currency, unlike peripheral countries with “original sin”. The Fed creates the definitive international money.
But heavy US foreign borrowing is transferred in real terms through large American trade deficits, mainly in manufactures.
The American concern with de-industrialization, i.e., unduly rapid job losses in manufacturing, should be linked to federal fiscal deficits and low American personal saving.
Exchange rate changes, foreign trade restraints, or tax breaks for manufacturers, won’t work.
Instead, with deliberate speed, move the federal budget from deficit to surplus.
US Current Account and Manufacturing Sector Trade Balance (% of GDP)
-6
-5
-4
-3
-2
-1
0
1
2
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2Q
CA Balance
Manufacturing Trade Balance
Source: Bureau of Economic Analysis
Projection of Labor Growth in Manufacturing under Balanced Manufacturing Trade
0.00
5.00
10.00
15.00
20.00
25.00
30.00
(%)
Share of ManufacturingEmployment
Projected Share of ManufacturingEmployment under BalancedManufacturing Trade
Conclusions for East Asia Collectively pegging to the dollar enlarges the
zone of stable dollar prices far beyond trade with the United States: stronger mutual anchoring of national price levels
Anchors against the threat of appreciation and deflation in creditor countries with “conflicted virtue”—while stabilizing mutual cross rates of exchange. Important for Japan and China.
Mutual exchange stability is a public good among integrated economies.
An “Asian euro” is but a distant possibility, so keying on the dollar is now the only feasible intra Asian mechanism for securing exchange stability.