from Follow the Money

An Asian OPEC?

February 24, 2005

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A less kind headline might be "Asian policy makers meet, agree to continue manipulating foreign exchange markets"

Still, this Bloomberg article (link thanks to Calculated Risk) suggests that there may be a bit of back story behind the statements that Japan, Korea and Taiwan put out indicating that they each had no intention of diversifying the currency composition of their reserves.

Asian officials agreed on Feb. 22 to set up an organization called the Asian Bellagio Group to stabilize regional foreign-exchange markets, the Korea Times reported ... ``What happened with Korea was not desirable and not what they wanted,’’ said Stephen Jen, global head of currency research at Morgan Stanley in London. ``The interests of the group is that they should do nothing to undermine the value of the dollar.’’

Barry Eichengreen of Berkeley has argued that Bretton Woods 1 -- the system of fixed exchange rates set up after the World War 2 -- only lasted as long as it did because it was backed by a set of institutions that made it easier for the world’s central banks to cooperate to support the system. The key players at the time were mostly in Europe, so most of the institutions had an "Atlantic" tilt. These institutions were more than just talking shops: there was a core commitment by the central banks not to convert their dollars into gold (and to jointly intervene in the gold market). Remember, in the initial Bretton Woods system, the dollar was pegged to gold, and everyone else pegged to the dollar. This kept Bretton Woods 1 going long after it was clear that the US lacked the gold needed to back all the dollars that the world’s central banks were holding.

Eichengreen observed that similar institutions to facilitate cooperation were lacking, and concluded that Asia would not be able to agree on who should bear the burden of supporting the dollar. The temptation to diversify (or at least try to diversity) before the other guy would be too strong.

Of course, there is an alternative thesis: new institutions will be created to help generate the needed cooperation.

Count me a skeptic. I want to see the "Asian Bellagio" countries do more than just coordinate the announcement that the big players have no intent to diversify.

Sure, all the big Asian economies would rather not see their currencies appreciate against the dollar, particularly if China remains wedded to its peg. But each Asian economy would presumably also prefer to see someone else add to its dollar reserves and take the (future) losses associated with providing the US with the financing the US needs for the system to keep on going.

Stephen Jen’s take on all this continues to amuse me. Jen, Morgan Stanley’s chief currency strategist, believes that the dollar is fundamentally undervalued, despite the growing US trade deficit. Tis true that most countries in the world would rather not see their currencies appreciate against the dollar.

``It’s in nobody’s interest for the dollar to fall,’’ said Jen. ``The Europeans are clear they don’t want to see the dollar fall further, so are the Japanese, and now the other Asian countries are saying it.’’

But if nobody’s currency appreciates against the dollar, the United States’ need for external financing is likely to keep on going up along with the expanding US trade deficit. The real question continues to be "who is willing to finance the US in order to keep their currency from appreciating?" So far this year, the only central banks that has building up its dollar reserves at a rapid pace seems to be Bank Negara Malaysia and the People’s Bank of China, though China has not confirmed this with the release of their January reserve data.

I suspect some other central banks may need to enter the market to keep the dollar from depreciating and, in the process, provide the US with the financing it needs to US run large current account deficits. Just a hunch.

I don’t think the system of Asian reserve financing is stable, but I also don’t think it will come to a clean, sudden end either. There will be lots of fumbling around before interests are clarified and the really hard decisions are taken ...

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