1CIER, Sept 2008

A SINGLE CURRENCY FOR THE GREATER A SINGLE CURRENCY FOR THE GREATER CHINESE ECONOMIC AREACHINESE ECONOMIC AREA

──The EU Paradiam Reconsidered─The EU Paradiam Reconsidered─

presented by

Dr. Cherng-Shin OuyangResearch Fellow

ouyang@cier.edu.tw

Chung-Hua Institution for Economic Research75, Chang-Hsin St.,Taipei, Taiwan

Conference on The Economic and Security Situation after Taiwan’s Elections23 September 2008

Organized by the Centre of East Asia Study, Institute of Political Studies, Polish Academy of Sciences,

in collaboration with Warsaw School of Economics and the Taipei Economic and Cultural Office in Poland

Sponsored by Taipei Economic and Cultural Office in Poland, and the National Sciences Council (ROC-Taiwan)

2CIER, Sept 2008

Glossary

AFC Asian Financial Crisis

AMF Asian Monetary Fund

AMO Asian Monetary Organization

ASEAN Association of South East Asia Nations

CAD Currency Areas Delimiting/demarcation

CBC Central Bank of China

CBS Currency Board System

CCA Common Currency Area

CCBGs Committee of Central Bank Governors

CECA Closer Economic Cooperation Arrangement

CEPA Closer Economic Partnership Arrangement

DPP Democratic Progressive Party

EAMA East Asian Monetary Authority

ECB European Central Bank

ECSC European Coal and Steel Community

EEC European Economic Community

EMCF European Monetary Cooperation Fund

EMS European Monetary System

EMU European Monetary Union

ERM Exchange Rate Mechanism

ESCB European System of Central Bank

EU European Union

GCC Gulf Cooperation Council

GCEA Greater Chinese Economic Area

HKMA Hong Kong Monetary Authority

IMF International Monetary Fund

KMT Koumingtan

MERCOSUR Mercado común del Sur

MNCs Multinational Companies

NAFTA North America Free Trade Agreement

3CIER, Sept 2008

Glossary

NIEs Newly-Industrializing Economies

NT$ New Taiwan Dollars

OCA Optimum Currency Area

OPEC Organization of Petroleum Exporting Countries

PRC People’s Republic of China

RMB renminbi

SAR Special Administration Region

SCA Single Currency Agenda

SEZs Special Economic Zones

WTO World Trade Organization

4CIER, Sept 2008

Contents

1- Introduction

2- The EU Paradigm in Perspective

2.1 A Brief History of EMU

2.2 Implications of the EMU

2.3 Future Prospect

5CIER, Sept 2008

Contents

3- Single Currency in East Asia or GCEA?

3.1 ASEAN-Plus

3.1.1 Monetary Cooperation :Phase 1

3.1.2 Monetary Cooperation: Phase 2

3.2 The Greater Chinese Economic Area

3.2.1 Axis-1 (China-Taiwan): Partly Suffocated

3.2.2 Axis-2 (Hong Kong-China): Vibrant As Ever

3.2.3 Axis-3 (Taiwan-Hong Kong): Unequal Dependence

3.3 ASEAN-Plus and GCEA: A Preliminary Comparison

3.4 Rebuilding Axis-1

6CIER, Sept 2008

Contents

4- Scope for Trans-Adaptation of EMU

4.1 The Tyranny of the Petrodollar Standard

4.1.1 Two Forms of Transfer

4.1.2 Hedging for Profit or Risk Management?

4.1.3 The Petrodollar Standard

4.2 Divorcing from the Dollar World

4.2.1 Consensus Building

4.2.2 Slow or Fast Track?

4.2.3 Monetary Union Depend on Pay-Offs Simulations

4.3. Objective Convergence Criteria versus Political Economy

4.3.1 Similarity and Differences

4.3.2 Irrelevance of the EU Paradigm

7CIER, Sept 2008

Contents

5- The Way Ahead

5.1 EU Paradigm Modified

5.2 Trouble-Maker: The US Ultra-Liberalism

5.3 CAD Prior to OCA in System Switch

5.4 Final Remarks

8CIER, Sept 2008

Fig.1 Currency Areas in terms of Foreign Assets Holding

￡ SFGCEA￥

Dollar World

EMU

9CIER, Sept 2008

Proposed Currency Areas

Western Africa underdeveloped infrastructure

MERCOSUR closed economy, high volatility in capital flows, interest conflict over dollarization

Gulf Cooperation Council

Huge difference in country size and disagreement on the location of central bank

NAFTA US insistence on a dominant role for the federal reserve system and US$ and Canada’s uneven economic geography

ASEAN+3(East Asia Minor)

Adherence to the non-interference principle on domestic affairs, disagreement on the composition of a currency basket

GCEA Political hindrance (Taiwan) One China, two systems (Hong Kong)

10CIER, Sept 2008

Footprint of Euro

•ECSC (1951)

•EEC (1957)

•EC (1967)

•EMS (1979)

•Whitle Paper on Completion of the Internal Market (1985)

•Single Market Act (1991)

•Treaty of Maastricht (1991)

•ECU (1992)

•EU (1993)

•The Stability and Growth Pact (1997)

•EMU (1999) ： 11 Member Eurozone, Dual Circulation

•EMU (2002) ： Single Currency

•25 Member EU (2004)

•13 Member Eurozone (2007)

•15 Member Eurozone (2008)

11CIER, Sept 2008

Characteristics of the EMU

Broad-based experiment ever attempted through peaceful means

Triggered by strong program architects and governmental commitment

Carefully planned and forcefully implemented

Developed from grass-root, expanded through consensus building

Increasing ECB’s influence in world trade and finance

Global turmoil-weathering power rises in commensurate with the EU aspiration to forward-looking perspective

Growth of the euro-zone as a more cohesive shock absorber

12CIER, Sept 2008

Characteristics of the EMU

Sustained by drive towards continuous deepening and widening

The theory of the “optimal currency area” corroborated (Mundel/McKinnon)

Closely following the five-stages thesis for integration (Balassa)

Gradualism prevailed

Visible hands play a large part

Ad hoc policies become endogenous not exogenous variables throughout the integration process

13CIER, Sept 2008

Future Prospect

EU integration breaks record on many fronts

A monument or living paradigm ！

enlarged EU proper converted gradually into a more homogeneous and consolidated entity

Post-911 dollar started its landslide as never before; traders dump the US dollar and dollar-denominated assets round the world, more so after spiraling oil price (2003)

GDP of Eurozone (EU15)surpassed the US in 2007

14CIER, Sept 2008

Future Prospect

EU status would not have taken place without EMU: magic of the single currency agenda!

€ ， An increasingly powerful reserve currency of the world

The most fundamental change to the international monetary system since the collapse of the Breton Woods system

Might rival dollar as the world's paramount international reserve currency, heyday of dollar hegemony is foredoomed

15CIER, Sept 2008

Single Currency in East Asia or GCEA?

ASEAN-Plus （ GI ） has received more attention whereas GCEA （ GII ） conspicuous less

Level of market integration, ethnic-cultural homogeneity, geographical proximity, common heritage, GII substantially higher than that of GI

Institutional framework for cooperation and goal-setting, GI on a higher level

16CIER, Sept 2008

Monetary Cooperation of ASEAN-Plus: Phase 1

Creating an internal market: Reacting against regional protectionism posed by EU and NAFTA in 1990s

Reinforced at the Asian financial crisis (APC): to create the AMF

Taiwan: access to multilateral groupings restricted to sovereign states

17CIER, Sept 2008

Monetary Cooperation of ASEAN-Plus: Phase 2

“Chiang Mai Initiative” reached by ASEAN +3 for maintaining exchange rates stability (2000), FTA concluded alternatively between ASEAN and China (2002), Japan (2003) and South Korea (2006), each on a different basis

Signing of the ASEAN Constitution and the Economic Blueprint at the 13th ASEAN summit (2007)

China prioritized by ASEAN as the contracting partner for FTA

Building the institutional capacity to coordinate financial and monetary policies and to facilitate disclosure of information

18CIER, Sept 2008

The Greater Chinese Economic Area

Axis-1 (China-Taiwan) ： Partly Suffocated

Taiwan Mandatory regime on bilateral relations undergoes constant modifications

KMT sought to resume talks with Beijing, failed due to top-down repetitive sabotages: 1990s

De-sinocization mobilized by pan-Green separatists: 2000s~

China Adopts an open-door policy towards Taiwan and the world without discrimination

Main Features Asymmetric integration and dependence: trade, investment, financial linkages

Decade-spanning stagnation in development of bilateral ties entailing nothing but stalemate

19CIER, Sept 2008

The Greater Chinese Economic Area

Axis-2 (Hong Kong-China): Vibrant As Ever

Hong Kong A cosmopolitan trans-shipment hub

Regional headquarters of the MNCs

Survive the AFC upon first aid from Beijing

Currency Board System (CBS) introduced in 1983

Largest direct investor in China

Bilateral Ties: FTA Plus

CEPA-1(2004) CEPA-2 (2005) CEPA-3 (2007)

Main features Restructured and assimilated into the Zhu-river delta in southern China

Single currency agenda contradicts the “one country two systems” dictum

HKMA satisfied with the CBS

20CIER, Sept 2008

Monetary Cooperation of ASEAN-Plus: Phase 2

Axis-3 (Taiwan-Hong Kong): Unequal Dependence

“Taiwan-Hong Kong” interdependence devoid of less man-made obstacles

Taiwan depends more on Hong Kong than the other way round

Hong Kong exploit as much arbitration charges as the extra transaction costs incurred on Taiwan by having to do business with mainland China indirectly

The scope for bilateral convergence in monetary system considerably less than Axis-1 and Axis-2

21CIER, Sept 2008

GI and GII: A Preliminary Comparison

Formal integration in GI much higher than GII for the time being, in real terms GI lags substantially behind especially when contrasted against Axis-2

To close the gap: Axis-1has to be rehabilitated

Evidences: GII is more or less a homogeneous entity

Much less coordinating efforts are required in redressing intra-region differences along Axis-1 and Axis-2

Disparities in income and development levels are reducing rapidly

22CIER, Sept 2008

Rebuilding Axis-1

Post-election easing of age-old cross-Strait tensions

Taipei has taken the initiative for reapprochment

The rationales: to recoup the incalculable economic losses arising from the “suicidal” mainland China policies in the past

The new orthodox: reversing the past wrong-doings in a spirit of calculated and outgoing pragmatism

CEPA-like FTA to be negotiated with Beijing considered a priority

SCA cannot be excluded in the medium run as long as both the objective and subjective conditions are met

23CIER, Sept 2008

Scope for Trans-Adaptation of EMU

Motives for monetary union: (1) guard against the threat of financial crisis, (2) to enhance total welfare of the region concerned

The aborted East Asian model is reflective of the first and relatively modest objective

The EU model shows more characteristics of the second

For GCEA: ongoing crisis (a system- or mega-crisis) is of an utterly different specie

Those that have been taken hostage within reach of the crisis-chain start to look for emergence exit

EU, sheltered by a dense wall of euro-dominated internal market exhibits greater resilience

The critical questions: how are we to characterize the current crisis?

Secondly, what is the scope for trans-adaptation of the EU paradigm to the GCEA?

24CIER, Sept 2008

Tyranny of the Petrodollar Standard

Current crisis: categorically diverse in origin and manifestation

Crisis syndrome: plummeting US dollar, oil crisis, sub-prime mortgages, food shortages, inflation, climate changes, etc.

Causally related and in one way or the other

Against which conventional wisdom is powerless to diagnose or to rescue: APC pales by comparison

Has little to do with trade cycle nor that of speculative attacks on particular victims

But one of irremediable sclerosis that derives overwhelmingly from the intrinsic weakness of human brain in system design and maintenance (US ultra-liberalism)

In the monetary-financial sphere there is singularly one origin-the US economy, principally the discredited dollar standard

25CIER, Sept 2008

Forms of Wealth Transfer

Dollar tyranny delivers shock waves across the globe amounting to imposition of compulsory tax on ROW

Causes: the 911 attack, deteriorating US economic fundamentals, credibility deficit of Bush administration

Out of benign or vicious neglect: the Fed/US Treasury choose to do nothing ！

Burden sharing and diversification, dollar weakness entails enormous wealth transfer in two parts: stock and flow/visible and invisible

26CIER, Sept 2008

Forms of Wealth Transfer

Visible Impacts

Stock: wealth position of creditors nations dwindles (Major victims: China, Japan, OPEC, and the Asian NIEs)

Flow: US to print fiat currency and exports inflation to oil consumers by keeping dollar cheap while draining resources backwardly

27CIER, Sept 2008

Forms of Wealth Transfer

Invisible Impacts

exchange rate manipulation (viciously neglected!)

To reap and manage creditors assets according to the terms dictated by the Fed!

Dollar-anchored Central Banks (CBC) deprived of policy autonomy

Hypothesis awaits verification: game-based economic warfare in disguise staged by the US without declaration!

Dollar intrigue has positioned the US in a superior bargaining lever (70% of world trade invoiced in dollar)

28CIER, Sept 2008

Hedging for Profit or Risk Management?

Exchange rate risks and losses rise against dollar volatility (slide)

Losses are greater the more exported products are priced in dollar and sourcing of intermediate inputs priced in non-dollar

Chaos evidenced throughout chain-linked turmoil in crude futures, the housing mortgages and other financial derivatives traded in US dollar.

Critics bypass the more significant role of the derivatives markets

Drawing the borderline demarcating the role of financial derivatives market between risk-hedging and speculative gains: a barometer for diagnosing the world financial health

US monetary-financial authority, again, choose to neglect!

29CIER, Sept 2008

The Petrodollar Standard

World monetary-financial system in chaos in post-Bretton Woods era

Causes of world financial crisis still to be explored in depth but in origination crude oil denominated in US dollar (dating from 1973) is considered decisive in crisis contagion

30CIER, Sept 2008

Divorcing from the Dollar World

For GCEA, divorcing from the dollar world towards a “common currency area” is a priority for engineering a paradigm shift

Officially, the SCA is not an object of immediate concern for Beijing and Taipei

Switching from one system to a qualitatively different one is a multi-faceted and dynamic process of path searching and selection

System-switch involving more than one economy has to coordinate the decisions and efforts of all relevant participants

As a comparison, the euro-propelled EU expansion is a muscle-building process, whereas for the GCEA crisis- insulation is more decisive

31CIER, Sept 2008

Consensus Building

Contacts and resolution of issues on cross-Strait flows and cooperation resurface after power switch

The proposed CECA pact with Beijing signals an advance among others for cementing bilateral

It is high time to examine the claimed merits for establishing a yuan-bloc

The case is much simpler for launching the common currency in Hong Kong

Throughout the negotiation process tripartite consensus- building is indispensable

32CIER, Sept 2008

Slow or Fast Track?

Choice between slow and fast track in monetary union is preconditioned, weighted by decision-makers’ preferences

The Mundell-Balassa model has often been employed as the orthodox blueprint for monetary integration processes (hailed as the economist approach in the EU)

The EU model is unique; the validity of this model cannot be duplicated without modifications

In the case of GCEA the fast track would be the more credible (hailed as the monetarist approach) with crisis-circumventing as the top priority

Owing to the disproportionate weights of the GCEA-trio the proposed SCA is supposed to share greater resemblance with Slovenia’s entrance into the Eurozone

33CIER, Sept 2008

Monetary Union Depend on Pay-Offs Simulations

Decision to move towards a yuan-bloc conditional upon differences in the outcome of simulated intertemporal pay-off to the GCEA-trio in question

Two sets of criteria are employed for assessing differences in the outcome: i.e. visible and invisible wealth transfer

Three scenarios may be envisaged depending on the extent according to which the avowed decision is endogenous to the transfer processes: high, medium, and low

In the extreme (highly endogenous) case, creation of the yuan- bloc would trigger worldwide massacre of the dollar assets of which China, boasting huge dollar assets, becomes a major victim of its own decision

34CIER, Sept 2008

Monetary Union Depend on Pay-Offs Simulations

Concurrent with downsizing of the dollar world panic sale-off would drive the global economy to the brink of collapse

A dilemma in decision-making arises henceforth which is clearly undesirable but one that was not a problem for the EU

It seems illegitimate to contend that the polar opposite (low endogenous) scenario is more likely

The intermediate scenarios cannot be ruled out a priori

35CIER, Sept 2008

Objective Convergence Criteria versus Political Economy

EU economic and monetary integration: highly politically motivated

EU was not an OCC but a quasi-OCC up to the time when Single Market was formed in 1993

Evidences: greater intra-community convergence in terms of co-movement dynamics over the interval 1966~79 and 1979~92:

Cross-country correlation in employment growth grew from 0.49 to 0.63

Intra-country correlation decreased from 0.33 to 0.13 while that between selected sub-regions (e.g, Italy and Germany) increased from -0.09 to 0.23

EU expansion: picking accession candidates for widening

36CIER, Sept 2008

Similarity and Differences: EU and GCEA

Similarity (hypothesis):

Along axis-1 and axis-2: cross-Strait economic co-movements greater between sub-regions than broad economy

Absorption (akin to EU-widening after 2004): small parts (Taiwan and Hong Kong) being subsumed and assimilated (hypothesis to be rectified) into PRC instead of reciprocal assimilation between equal partners

Differences (hypothesis):

Along axis-1 and -2: GCEA based on disparate weight and greater inter-GCEA division of labour of the trio (in contrast to the oligopolistic power structure and greater intra-EU division of labour)

Motives for building the yuan-bloc: to disengage from the dollar world

Rationale: ascertaining “boundary conditions” for building the yuan-bloc prior to fulfillment of the objective criteria furnished by the process leading to the EMU

37CIER, Sept 2008

Relevance of the EU Paradigm

The schematic relevance of the EU paradigm to GCEA can be examined through two perspectives: that of the continued eastward expansion of the EU and the assumed non- optimality of the dollar-based GCEA.

Geopolitical considerations prevail over economic rationales in post-2004 EU expansion.

As a corollary, non-optimality of the dollar-based GCEA has two dimensions.

Dimension 1(hypothesis): to prove that the dollar standard adopted in current GCEA-trio cannot be sustained (is non-optimal); this may be verified by subdividing the wealth transfer effect into a “visible” and “invisible” part (see §4.1.1), both in terms of “stock” and “flow” by tracing associated changes in the macroeconomic variables of the GCEA-trio as against the dollar world

38CIER, Sept 2008

Relevance of the EU Paradigm

Deminsion-2 (hypothesis): to characterize the “boundary conditions” (i.e. threshold conditions demarcating one currency area from the other) by two methods: (1) the method of reductio ad absurdum along the three axes with respect to the US economy, respectively, and (2) the method for ascertaining the requirements for upholding the yuan-bloc

Addendum: there is no need to wait for RMB being made convertible internationally for introducing yuan as the common currency in GCEA; regionally convertible would suffice

39CIER, Sept 2008

The Way Ahead: EU Paradigm Modified

For many regional groupings on the pipeline creation of a region-based monetary union remains an attractive but distant luxury

Following the launch of euro revived interests and aspirations to the SCA duly followed throughout the world but mostly confined to thought experiments

Being a more compact and homogeneous entity the GCEA looks fit to initiate the project with less visible hindrance compared to ASEAN-plus

However, to divorce from the crisis-plagued dollar world the EU paradigm will have to be modified

In the same spirit this paper seeks to identify the prospect of similar design for the GCEA

40CIER, Sept 2008

The Way Ahead Trouble-Maker: The US Ultra-Liberalism

Source of trouble: world financial crisis originates almost exclusively from the US

Ultra-liberal capitalism: in genesis current crisis is totally different from that characterized by market disequilibrium, financial speculation, or trade cycle

Triple crisis in one: globalized US terrorism consists of oil, housing, and financial derivatives--each having a life cycle of its own emanating from a built-in system sclerosis exacerbated by decades-spanning twin-deficits (plus the credibility deficit of US Administration)

Burden diversification: unable to survive on its own US decision-makers have opted for an easy way out, to export home-grown disaster abroad

41CIER, Sept 2008

The Way Ahead Trouble-Maker: The US Ultra-Liberalism

Disengage from the dollar world once for all: it is feared that the US-germinating crisis will acquire a permanence of its own and resurrect in transformed form in one way or the other in the future

Means for doing so: a fundamental switch in monetary system

42CIER, Sept 2008

The Way Ahead: CAD Prior to OCA in System Switch

Framework for conducting system switch analysis (separated by boundary/threshold criteria of two currency regimes): static and dynamic

Comparative static (temporal equilibrium)

Two forms of decision rule (hypothesis) put forward in this paper

First rule in system switch (A): (CAD-based) net inter- regional transfer accrued to the OCA in question is positive

Second rule in system switch (B): net intra-regional transfer accrued to the OCA in question is positive

Third rule (C): conventional OCA theorem (Balassa-Mundel)

43CIER, Sept 2008

The Way Ahead: CAD Prior to OCA in System Switch

Application of the first rule for GCEA: net simulated (static) potential losses (gains) after transition by adhering to the dollar standard is greater (less) than that by adopting the yuan standard

Priority in use of decision rules based on set theory: C B A⊂ ⊂

System switch pays provided it can be validated by the results of simulation conducted for each of the GCEA-trio

Addendum (omit)

Dynamic (intertemporal equilibrium)

Invisible output-impact transfer due to changes in the degree of policy autonomy)

44CIER, Sept 2008

Final Remarks

Ranking in hierarchical order, CAD is the fundamental whereas OCA the secondary criteria in ascertaining the boundary conditions separating members from non-members of a monetary union

A monetary union is not just an emergency exit but a more durable artificial construct aimed at weathering the storm of future crisis; the disproportionate size of the GCEA-trio compared to that of the EMU suggests that considerably less coordinating efforts are involved in creating the yuan-bloc

The yuan-bloc is created in three consecutive steps but a quick fix is preferred

A multi-polar world is not feasible without yuan being made a key international reserve currency

A handsome amount of arguments and contentions presented in this essay are subject still to empirical verifications

45CIER, Sept 2008

Thank you for your Thank you for your attentionattention ！！