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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
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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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Global Currency in the FutureGlobal Currency in the Future
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
Professor Stefan Collignon
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Global Currency in the FutureGlobal Currency in the Future
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%
Professor Stefan Collignon
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Global Currency in the FutureGlobal Currency in the Future
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
Professor Stefan Collignon
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Global Currency in the FutureGlobal Currency in the Future
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
Professor Stefan Collignon
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Global Currency in the FutureGlobal Currency in the FutureProfessor Stefan Collignon
Unit labour costs relative to USA
20.0%
40.0%
60.0%
80.0%
100.0%
120.0%
140.0%
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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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Global Currency in the FutureGlobal Currency in the FutureProfessor Stefan Collignon
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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Global Currency in the FutureGlobal Currency in the FutureProfessor Stefan Collignon
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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Global Currency in the FutureGlobal Currency in the Future
The economic consequences of monetary instability • Lower investment
– Uncertainty “option value of waiting”
Professor Stefan Collignon
Investment share
0.1
0.15
0.2
0.25
0.3
0.35
0.4
1960
1962
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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
Professor Stefan Collignon
GDP Inflation
-5.0%
0.0%
5.0%
10.0%
15.0%
20.0%
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Euro area (incl. linked Germany) United States Japan
EuroGerman unification
2. Oil shock1. Oil shock
Bretton Woods
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Global Currency in the FutureGlobal Currency in the FutureProfessor Stefan Collignon
GDP growth rates 5 year centred moving average
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
1960
1962
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1966
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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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Global Currency in the FutureGlobal Currency in the Future
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
Professor Stefan Collignon
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Global Currency in the FutureGlobal Currency in the FutureProfessor Stefan Collignon
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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Global Currency in the FutureGlobal Currency in the Future
Figure 2.4 (a): Share of currency zones in world exports
0
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1978 1983 1988 1992
in p
erce
nt
dollar
yen
EMS
no anchor
Benessy-Quéré in CEPII 63 (1995)
Professor Stefan Collignon
Figure 2.4 (b): Export share of currency zones as % of world exports
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25
30
35
40
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50
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1979
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dollar zone
DM zone
CHELEM and own calculations
Bloc floating
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Global Currency in the FutureGlobal Currency in the Future
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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Global Currency in the FutureGlobal Currency in the Future
The economic consequences of currency blocs
• 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)
Professor Stefan Collignon
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Global Currency in the FutureGlobal Currency in the Future
The economic consequences of currency blocs
• 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
Professor Stefan Collignon
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Global Currency in the FutureGlobal Currency in the Future
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
Professor Stefan Collignon
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Global Currency in the FutureGlobal Currency in the FutureProfessor Stefan Collignon
Balance of net exports
-600
-500
-400
-300
-200
-100
0
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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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Global Currency in the FutureGlobal Currency in the Future
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
Professor Stefan Collignon
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Global Currency in the FutureGlobal Currency in the Future
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
Professor Stefan Collignon
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Global Currency in the FutureGlobal Currency in the FutureProfessor Stefan Collignon
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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Global Currency in the FutureGlobal Currency in the Future
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
Professor Stefan Collignon
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Global Currency in the FutureGlobal Currency in the Future
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
Professor Stefan Collignon
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Global Currency in the FutureGlobal Currency in the Future
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
Professor Stefan Collignon
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Global Currency in the FutureGlobal Currency in the Future
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
Professor Stefan Collignon
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Global Currency in the FutureGlobal Currency in the Future
Thank you!
Professor Stefan Collignon