1 global currency in the future professor stefan collignon monetary cooperation between asia and...

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Global Currency in the FutureGlobal Currency in the FutureProfessor Stefan Collignon

Monetary cooperation between Asia and Europe

Mizuho Research Institute Ltd. Tokyo24 November 2004

Stefan Collignon

Professor of European Political Economy, LSE

www.stefan collignon.de

http://images.google.com/imgres?imgurl=www.inf.ethz.ch/personal/stengel/Gif/lse-new.gif&imgrefurl=http://www.inf.ethz.ch/personal/stengel/&h=524&w=522&prev=/images%3Fq%3DLSE%26start%3D40%26svnum%3D10%26hl%3Den%26lr%3D%26ie%3DUTF-8%26oe%3DUTF-8%26sa%3DN

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Global Currency in the FutureGlobal Currency in the Future

Exchange rate regimes matter for long term economic development

1. Exchange rate levels • determine relative price levels between goods and

assets across nations – Competitiveness– Profitability of capital invested

• determine relative attractiveness for foreign direct investment (FDI) investment

– Multinational firms look at global investment opportunities– Integration into world economy

Professor Stefan Collignon


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Exchange rate regimes matter for long term economic development

2. Exchange rate volatility creates uncertainty about relative prices and profits

• Portfolio investors should be indifferent as long as derivative markets allow them to hedge

• Local exporters and FDI-investors cannot hedge given long term horizon of their production facilities



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Exchange rate volatility creates uncertainty about relative prices and profits

• Risk averse firms look at the risk-return trade-off of location strategies

• The trade-off exists (Bénassy-Quéré et alt. 2001)

- a 1% appreciation in real exchange rate reduces FDI stock by 0.22%- a 1% increase in exchange rate volatility reduces it by 0.60%



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Institutions matter

1. Bretton Woods created a framework for economic stability

– fast development of Europe and Japan after the war

– based on the leadership of a benevolent hegemon

– Stable undervaluation of Japanese and European currencies



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2. After Bretton Woods (1971) came the market-led international monetary system

• Rise of financial markets

• Large transborder financial flows

• Undervaluation turned into overvaluation

• High exchange rate volatility



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Unit labour costs relative to USA

20.0%

40.0%

60.0%

80.0%

100.0%

120.0%

140.0%

19

60

19

62

19

64

19

66

19

68

19

70

19

72

19

74

19

76

19

78

19

80

19

82

19

84

19

86

19

88

19

90

19

92

19

94

19

96

19

98

20

00

20

02

20

04

Euro area (incl. West Germany) Germany United Kingdom Japan United States

Bretton Woods

Plaza Agreement

EMS

Euro

ERM crisis

Asian crisis

• Undervaluation turned into overvaluation


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1960 1970 1980 1990 2000

-1.0

-0.5LUSD per DM

1960 1970 1980 1990 2000

-0.1

0.0

0.1 DLUSD per DM

1960 1970 1980 1990 2000

-0.25

0.00

0.25

0.50D12LUSD per DM

1960 1970 1980 1990 2000

0.0

0.5 D24LUSD per DM

1960 1970 1980 1990 2000

-0.5

0.0

0.5D60LUSD per DM

High exchange rate volatility

Forecasting future exchange rates (and relative price levels) becomes highly uncertain

1. Example: DM/euro-dollar


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100

200

300

100

200

1980 1985 1990 1995 2000

USD

euro

annual volatility

1980 1985 1990 1995 2000

-0.1

0.0

0.1monthly volatility

1980 1985 1990 1995 2000

-0.25

0.00

0.25

1980 1985 1990 1995 2000

-0.5

0.0

0.5

Yen-dollar exchange rates

volatyility over 2 years

Red = USDBlue = euro

1980 1985 1990 1995 2000

-0.5

0.0

volatility over 5 years

2. Example: Japan


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The economic consequences of monetary instability • Lower investment

– Uncertainty “option value of waiting”


Investment share

0.1

0.15

0.2

0.25

0.3

0.35

0.4

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

Euro area United States Japan

EuroGerman unif ication

Bretton Woods Plaza Agreement

1. Oil shock 2. Oil shock

Asian crisis


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Global Currency in the FutureGlobal Currency in the FutureThe economic consequences of monetary instability • Inflation persistence

– Devaluations import price increases– Revaluations dampen growth


GDP Inflation

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

19

60

19

62

19

64

19

66

19

68

19

70

19

72

19

74

19

76

19

78

19

80

19

82

19

84

19

86

19

88

19

90

19

92

19

94

19

96

19

98

20

00

20

02

20

04

Euro area (incl. linked Germany) United States Japan

EuroGerman unification

2. Oil shock1. Oil shock

Bretton Woods


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GDP growth rates 5 year centred moving average

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

5 yr Ma United States Japan Euro area

Bretton Woods EMS & disinflation EuroERM crisis

Asian crisisJapan crash

The economic consequences of monetary instability • Economic stagnation

– obviously other factor matter as well


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The political reactions to monetary instability

1. In Europe• European Monetary System in 1979

– Creating a “zone of monetary instability

– Pegging to DM as inflation anchor

• Supply-side reforms– Single European Act 1986

• European Monetary Union in 1999



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2. Worldwide

• The emergence of currency blocs

– Deutschmark bloc increasing in 1980 and 90s

But euro is not currency bloc, but new currency

– Asian countries peg to dollar– No yen bloc emerging

The political reactions to monetary instability


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Figure 2.4 (a): Share of currency zones in world exports

0

10

20

30

40

50

60

70

80

90

100

1978 1983 1988 1992

in p

erce

nt

dollar

yen

EMS

no anchor

Benessy-Quéré in CEPII 63 (1995)


Figure 2.4 (b): Export share of currency zones as % of world exports

20

25

30

35

40

45

50

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

dollar zone

DM zone

CHELEM and own calculations

Bloc floating


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The economic consequences of currency blocs

• Pegging to dollar allowed emerging Asia the integration into world economy

- The most dramatic change of trade pattern has taken place in the share of manufacturing exports from developing countries (from 18.5% to 66.1%) and especially in Asia (from 22.4% to 73.4%)



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• But in Europe it created a deflationary bias and led to the break-up in 1992/3– the bloc was no longer undervalued with

respect to the dollar– The Deutschmark was too small as an anchor

currency– Solution: euro

• Transformed the EU-economy• Created large trade gains (10-100 percent)



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• An unexpected result:– Exchange rate volatility between currency blocs

increases as the blocs get bigger– The fundamental (equilibrium) exchange rate

must move more to help the adjustment of the anchor currency

– Uncertainty increases as markets can no longer perceive the right equilibrium



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Example: USA• The high current account deficit requires an

adjustment by depreciating the exchange rate• But only the trade with the non-dollar zone would

be affected• Hence, the adjustment of the flexible exchange

rate is much larger than it would otherwise be.• Consequence: euro and yen become more easily

overvalued



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Balance of net exports

-600

-500

-400

-300

-200

-100

0

100

200

300

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

2005

bn

eu

ros

Euro area Euro area (incl. West Germany) United States Japan

Plaza German unif ication Euro

Asian crisis

US trade deficit is € 500 bn

•Financed by Euro-surplus of €200 bn

•And Japanese surplus of €100 bn

•Rest comes mainly from Asia


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The problem with today’s world economy (1)• Emerging Asia is pegged unilaterally to dollar• It achieves high growth because of undervaluation

(especially China)• USA can only act on yen and euro-exchange rates

for adjustment• This will cause overvaluations of euro and yen• Growth of Japan and Euroland will stagnate



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The problem with today’s world economy (2)• Emerging Asia will also suffer from high volatility of euro and

yen relative to dollar

• Japan exports twice as much to US (and to Asia) as to EU, but imports are more balanced

• China exports more to EU than to USA and Asia, but imports from Asia are important

• India exports slightly more to EU and USA, but imports 3 times as much from EU and very little from rest of Asia

• ASEAN has a fairly balanced trade portfolio between EU and US, but much more exposure to Asia



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Regional Trade distribution

2000 EU EU US US ASIA ASIA

export import export import export import

Japan 16.4% 12.3% 30.0% 19.1% 29.0% 34.3%

China 24.5% 7.2% 20.9% 9.9% 21.8% 29.3%

Korea 13.6% 9.8% 21.8% 18.2% 35.0% 39.6%

India 27.9% 22.4% 26.0% 7.3% 6.6% 8.5%

ASEAN 14.8% 11.2% 17.6% 14.0% 21.6% 29.5%

Asia 17.1% 10.6% 23.3% 15.5% 26.1% 32.6%

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The problem with today’s world economy (3)

• Conclusion: Asia’s trade is as dependent on the US as it is on the EU– Shifts in the dollar-euro exchange rate have detrimental

effects on either trade relation

• Regional trade within Asia has become a key market– At the moment this trade is stabilised by the dollar peg (like

European integration under Bretton Woods)– If US impose “more flexibility”, the foundations of emerging

Asia’s success will disappear, as they did for Europe and Japan after Bretton Woods


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Possible solutions1. Stabilise the triade dollar-yen-euro

– Requires cooperation with USA: impossible2. Stabilise euro-yen exchange rate

– Requires cooperation Japan-Europe– Not impossible, but difficult with the institutional

deficiencies of Euro-governance

3. Stabilise euro-renminbi exchange rate– Possible as alternative peg to USA– Would also stabilise trade for other Asian countries


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Possible solutions4. Peg to a regional Asian anchor

– Which anchor?

– Unresolved history

– Slow process

– But: financial cooperation has started

– Next: Asian currency unit?

– Monetary cooperation in Asia is necessary because high degree of regional trade integration



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My preferred solution:More monetary cooperation between Asia and

Europe in order to protect the world from potential destabilisation from USA

– Need to stabilise euro-yen for financial flows– Need to stabilise Asian trade for world

demand– Need to stabilise euro to prevent disastrous

overvaluation and maintain growth and employment



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Thank you!



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