Exchange rate co-ordination for surmounting the East Asian currency crises
✍ Scribed by Ronald I. McKinnon
- Publisher
- John Wiley and Sons
- Year
- 1999
- Tongue
- English
- Weight
- 132 KB
- Volume
- 11
- Category
- Article
- ISSN
- 0954-1748
No coin nor oath required. For personal study only.
✦ Synopsis
interest rates necessary today for defending spot exchange rates are still higher than they need be. Further progress is slowly nudging spot rates upward through time, so as to increase dollar values of their currencies expected in the future, could prevent further rounds of `beggar-thy-neighbour' devaluations while keeping a lid on interest rates.
Second, and in contrast to the EA Five, the expected dollar value of the yen into the distant future is too high Ð although Japan's spot exchange rate is close to equilibrium. (The current purchasing power parity (PPP) rate is about 120 to 130 yen to the dollar.) Because of this expectation that the yen will rise ever higher, Japan's nominal (but not real) interest rates in the late 1990s are too low.
Third, as in the fairy tale of Goldilocks and the Three Bears, I shall argue that China's (and Hong Kong's) forward exchange rate is just right Ð as is China's system of capital controls for containing, albeit imperfectly, moral hazard in its banks. The existing spot exchange rate of 8.3 renminbi per dollar has been stable for about four years and domestic in¯ation has been eliminated. Also by late 1998, Chinese domestic interest rates have come down to American levels. Thus, China's forward exchange rate against the dollar (implicit because of China's capital controls) is the same as its spot rate. No change in spot or forward yuan/dollar exchange rates, or in China's system of capital controls (except for strengthening), is expected or called for.
Today's `just right' exchange-rate cum interest-rate structure for China is contingent on arresting the economic slump in Japan, and on reviving the East Asian Five Ð while stabilizing their (dollar) exchange rates: pretty strong conditions. Indeed, the most intractable problem is the exchange-rate related slump in Japan Ð which I discuss in detail below. But, if China lets the yuan begin depreciating, no sustainable equilibrium for the East Asian economy would exist.
Despite widespread criticism, the International Monetary Fund's insistence on fundamental banking and industrial reforms in the East Asian Five is correct conceptually. Before the 1997 crisis, explicit or implicit deposit guarantees from their national governments induced banks and other ®nancial institutions to gamble by making risky loans, and to ®nance these by issuing short-term debts denominated in foreign currencies Ð largely dollars and yen. Although by the purchasing power parity (PPP) criterion their exchange rates were not misaligned, this asset-market disequilibrium made them vulnerable to forced devaluations.
However, the post-crash management of exchange rates in East Asia remains a collective problem. After nudging their exchange rates back up toward PPP, the EA Five should re-adopt targets for their dollar exchange rates similar to their policies before 1997 Ð but this time with tighter prudential regulation of the banking system and short-term capital ¯ows in place. Building on the success of Hong Kong and China, adopting of a more formal system of benchmark dollar parities throughout the East Asian region would provide greater mutual exchange rate security.
In light of the current ®nancial disarray in the EA Five and in Japan, creating a zone of monetary and exchange rate stability in Asia, with the dollar as the anchor currency, might seem next to impossible. But, except for Japan, such a zone did exist, if only approximately, before the 1997 crash! The smaller Asian economies were formally or informally pegged to the dollar Ð although sometimes the peg, as in the case Indonesia, slid or crawled.
But the `loose cannon' in the pre-1997 East Asian exchange rate regime was the yen/ dollar exchange rate. Cyclical variations in the real yen/dollar rate upset the