monetary cooperation in east asia: a survey

7/28/2019 Monetary Cooperation in East Asia: A Survey

1/63

ECONOMICS AND RESEARCH DEPARTMENT

ERD WORKING PAPER SERIES NO. 13

Raul Fabella

May 2002

Asian Development Bank

Monetary Cooperation

in East Asia: A Survey


2/63

49

ERD Working Paper No. 13

MONETARY COOPERATION IN EAST ASIA:

A SURVEY

Raul Fabella

May 2002

Raul Fabella is Dean of the School of Economics, University of the Philippines. This paper was written

while the author was a Sta f f Consultant of the Asian Development Bank.


3/63


MONETARY COOPERATIONIN EAST ASIA: A SURVEY

50

Asian D evelopment B an k

P.O. Box 789

0980 Manila

Philippines

2002 by Asian Development Bank

May 2002

IS SN 1655-5252

The views expressed in this paper

are those of the author(s) and do not

necessarily reflect the views or policies

of the Asian Development B ank.


4/63

51

Foreword

The ERD Working Paper Series is a forum for ongoing and recently

completed resea rch an d policy stud ies underta ken in the Asia n Development B a nk

or on its behalf. The Series is a quick-dissemina ting, informa l publica tion mea nt

to stimula te discussion a nd elicit feedback. Pa pers published under th is Series

could subsequent ly be revised for publication a s a rt icles in professiona l journa ls

or chapters in books.


5/63



54

Contents

Abbrevia t ions vii

Abst ra ct ix

I . Int roduct ion 1

I I . Currency U nions a nd the E uropea n Moneta ry U nion 2

A. E xt a nt U nions 2

B . The E uropea n Moneta ry U nion 3

I I I. C ur ren t E xch a ng e R a t e R eg im e

a nd Moneta ry Coopera t ion in E a st Asia 9

A. F ea t ures 9

B . Robust ness 10

C. D ra w ba cks 11

IV. Proposa ls for Moneta ry and Exchange Ra te

Coopera t ion in E a st Asia 11

A. Willia msons C ommon B a sket P eg 12

B . Asia n E xcha nge Ra te Mecha nism 15

C. The Yen B lock P roposa l 17

D . E va lua t ion 18

V. Cost s a nd B enefit s of a Moneta ry U nion in E a st Asia 19

A. The E vidence on E conomic Fea sibilit y 19

B . C ommon Currency for Asea n+ 3 23


6/63

55

VI. Noneconomic Hurdles and P ursuit Archi tecture

for Asia s Monet a ry U nion 26

A. E urola nds U ndue Adva nt a ges 26

B . E a st Asia 28C . P ursuit Archit ect ure 29

D. The Mundell-Fleming Impera t ive:

The D ebt S ervice P a ss-through 30

VII . C onclusion 31

Appendix A: Int erna t iona l Moneta ry Arra ngement s 33

a nd t he Mundell-Fleming C onsistency Ru les:

Lessons for E a st Asia

Appendix B : 41

Ta ble 1: Ea st Asia n F orex Reserves Accumula tion a s %of G DP

Ta ble 2: S hock S ymmet ry

Ta ble 3: Fa ctor Mobilty, S peed of Adjustm ent , Development

Ta ble 4: Aggrega te OC A a nd Ma a str icht Indices

Appendix C : On t he E xcha nge Ra t e Regime 43

a nd E ndogenous B ehavior: The Ca se of the Fr ench

Socialist P rogram

Appen dix D : F our F ea rs th at S ust a ined Eur opea n Int egr at ion 44

References 46


7/63



52

Abbreviations

ACU Asia n currency unit

AE RM Asia n excha nge ra t e mecha nism

AS E AN Associa t ion of S out hea st Asia n Na t ions

B B C Willia msons common ba sket peg

E CB E uropea n C ent ra l B a nk

E CU E uropea n currency unit

E MI E uropea n Monet a ry Inst it ut eE MS E uropea n Monet a ry S yst em

E MU E uropea n Monet a ry U nion

E RM excha nge ra t e mecha nism

IMF Int erna t iona l Monet a ry Fund

NAFTA Nort h America n Free Tra de Agreement

OCA opt imum currency a rea

VS TFF very shor t t erm fina ncing fa cilit y


8/63

53

Abstract

This paper surveys t he growing literat ure on moneta ry cooperat ion in E a st

Asia that goes beyond the Chiang Mai Initiative. It compares and contrasts the

various proposals for cooperation such as the Williamson basket peg, the Asian

monetary system, a nd th e yen block as t o their crisis prevention impact a nd th eir

feas ibility, both economic a nd political. The pa per als o review s th e evidence on t he

readiness of Ea st Asia a nd some of its proper subsets for a currency union in th e

light of experiences elsewhere, especially of European monetary cooperation. Onpure optimum currency area calculus a lone, a case can be ma de for a n E a st Asia n

currency union. B ut t he great historica l, developmenta l, politica l, an d cultura l di-

versity here highlighted sta nds a s a formida ble obsta cle. Nonetheless, a s th e expe-

rience of Euroland shows, the very pursuit of even such a distant vision already

brings benefits to part icipant s.


9/63

1

I. INTRODUCTION

The Maa stricht Treat y of December 1991 a nd t he establishment of the E uropean Monetar y

Inst itute (1994) to shepherd the push toward the European Monetary Union (EMU)

produced the potential threat of a Fortress Europe , which galvanized the forces for

economic integration in East Asia. The birth of the North American Free Trade Agreement (NAFTA)

great ly reinforced t his integra tionist a genda. The response took th e form of the ill-fat ed Ea st Asian

Economic Caucus proposed by Malaysia and subsequently the more inclusive Asia Pacific EconomicCooperat ion (AP EC ). Within th e Associat ion of S outheast Asian Na tions (ASE AN), t he a genda

beca me embodied in the Common Economic Pr eferentia l Ta riff wit h its a mbitious 10-yea r ta riff

reduction program.

B efore th e Asia n currency crisis of 1997-1998, Ea st Asia w a s a zone of unpa ra lleled success

and assertiveness. The Asian crisis injected an element of fragility into East Asias economic

a chievement. Su ddenly, the formida ble ma chine buckled a nd currencies t umbled. The moneta ry

a nd excha nge rate ma na gement of the Ea st Asian model wa s vulnera ble. A new para digm wa s

being mandated by a new reality.

The literature on the exchange rate expanded in the aftermath of the crisis to embrace

the tw o-cor ner solut ionof either t he free floa t of th e currency or a h a rd peg. The la tt er could involve

a curr ency boar d(Fischer 2001) under unilateral stabilizat ion, or common cur r encyunder

multilatera l stabilizat ion. Dollarization, a nother fringe solution under unila teral sta bilization an d

a complete surrender of domestic money, gained some respectabili ty (Hausman 2001). The

underlying paradigm is the Mundell-Fleming open economy macroeconomics (Mundell 1963) with

fully open capita l a ccount a nd t he consequent full operat ion of the impossible trinit y.

Eichengreen (1994) sta rted t he debat e on t he possibility of moneta ry cooperat ion in Ea st

Asia in 1994. It was, however, the Asian crisis that gave it urgency, especially the observation

tha t t he drast ic appreciat ion of the domina nt a nchor currency, the US dolla r, wa s partly t o blame

for the crisis. This was reminiscent of the drastic appreciation of the deutschmark in the run-

up to the European currency crisis in 1992-1993.

This paper is a survey of the va rious fa cets of moneta ry, f ina ncial , a nd excha nge ra tecooperation, reflected by the expanding literature in theory and practice in order to draw inferences

for the prospects and challenges of greater monetary cooperation in East Asia.

In S ection II, w e summa rize past experiences in currency union and focus on th e structure

of the EMU tha t st ar ted on 1 J an uar y 2000, the sa feguards adopted to ensure success an d its


10/63



2

precursors, ma rket integrat ion, a nd t he Europea n Moneta ry S ystem (EMS). In S ect ion I II , we

examine the post-Asian crisis exchange rate and monetary regime in East Asia including the

cooperative mechanisms adopted to fend off speculative attacks. Section IV examines and compares

the competing cooperat ive moneta ry a rra ngements proposed to stabilize excha nge ra tes a nd serve

a s a tra nsitory sta ge to the Asian Monetary Un ion. In Sect ion V, we view the evidence for a n

Ea st Asian optimum currency a rea (OCA) and t a ckle the costs a nd benefits of a n Asian Monetary

U nion. In S ection VI, we discuss the noneconomic hurdles an d suggest a feasible pursuit a rchitecture

toward a monetary union in East Asia. Section VII concludes.

II. CURRENCY UNIONS AND THE EUROPEAN MONETARY UNION

In this section, we train our attention on the focus of global interest, the European Monetary

U nion. After reviewing its st ructure, w e deliberat e on its precursors, na mely, economic integra tion

and the EMS.A currency union is a zone consisting of several countries or regions where (i) a single

currency circulat es; (ii) a single moneta ry a uth ority implements moneta ry policy defined a t t he

union level; (iii) a single excha nge policy prevails (IMF 2001); a nd (iv) th e single moneta ry a uth ority

ma inta ins a common pool of reserves; (v) in t he a bsence of political int egrat ion. Oth er feat ures

tha t ma y or ma y not a ccompany currency unions a re open external capita l account, open internal

capital account, and economic integration such as a Free Trade Area, all of which are true for

the EMU.

A. Extant Unions

Existing currency unions include (IMF 2001):

(i) The Eastern Car ibbean Currency Union founded in 1983 with the currency Ea s tern

Ca ribbea n Dollar, pegged to the US d ollar in a Semi-Curr ency B oa rd syst em. The

common monetary authority is the Eastern Caribbean Central Bank.

(i i) The West e rn Afr ica E conomic and Mone t a ry U n ion founded in 1994 wi t h t he

currency, th e CFA Fra nc, pegged to the Eur o under a Cur rency Boa rd. The moneta ry

aut hority is t he Centra l Ba nk of Western Africa n St at es.

(i i i) The Central Africa E conomic and Monetary Community founded in 1974 with the

currency CF A Fra nc pegged to the Euro under a Cur rency Boar d system. Moneta ry

aut hority is exercised by the Ba nk of Centra l African St a tes.(iv) The European Monetary Union founded on 1 J anuary 1999, with the currency, Euro

on a flexible excha nge rat e. The moneta ry a uthority is the E uropean C entra l B a nk

(ECB).

The first th ree are remna nts of a common colonial herita ge with a single currency. Only

the E MU ha d a profound impact on popula r a nd policyma kers ima ginat ion because it s ta rted


11/63

3

Section IICurrency Unions and the European Monetary Union

from countries with separa te na tional currencies. In t he words of Richard P ortes, director of the

Cent er for E conomic P olicy Resear ch, The EMU is wit hout th e slightest doubt th e biggest cha nge

in interna tiona l financia l system since Brett on Woods (RE S Newsletter2001). F or more on t he

issues surrounding currency unions a nd t he surrender of moneta ry policy, refer to Appendix A

for experiences of past global monetary arrangements.

B. The European Monetary Union

On 1 J a nua ry 1999, the Euro wa s introduced a s legal tender in th e 11 countries comprising

the Eu ropean single-currency a rea (Euroland from hereon). Un til 1 J a nua ry 2002, the Euro wa s

only a unit of account for book tra nsa ctions. The E CB took over exclusive moneta ry policy for

Eur ola nd from 1 J a nua ry 1999. By 1 J uly 2002, na tiona l currencies will cea se to exist. B efore

we review t he structure and sa feguards of the EMU, w e first dw ell on the ant ecedents of the EMU,

na mely, economic integrat ion a nd t he European Monetary Syst em.

1. Precursor of the EMU:

Denationalization and Economic Integration of Europe

The 50 year s preceding the E MU can be viewed a s a persistent , if sometimes spa smodic,

dena tiona lizat ion of various symbols of na tional sovereignty . This fitt ed in well wit h t he vision

set d own in Altiero Spinellis Ventotene M ani festo, which saw na tionalism at the root of European

wa rs a nd federa lism as t he salvat ion. The Marsha ll Pla n, wh ich spea rheaded the recovery and

reconstruction of Europe, ha d a n unm istaka ble pa n-European flavor. Marsha ll aid w a s supported

by a supranational overseer, the Organization for European Economic Cooperation. This effectively

denat iona lized U S a id, fa voring closer economic coordina tion in Western E urope, w hich eventua lly

spawned a common management of French and German coal and steel, both central to Europes

reconstruction. This w a s th e Europea n C oa l a nd S teel Communit y, brought int o existence by th e

Schuman P lan of federalist visiona ry J ean Monnet , a lso known a s the Fa ther of Europe, with

the support of French foreign minister Robert Schuma n a nd G erman Cha ncellor Konra d Adena uer.

For Monnet, the European Coal and Steel Community, which denationalized steel and coal, was

just a stepping st one to a bigger, if still premat ure, project, the E uropean Economic Community

(EC C), which came int o being w ith t he signing by six countries of the Trea ty of Rome in 1957.

The ECC , which denat iona lized customs duties, wa s ma na ged by the Eur opea n Commission, w hose

decisions, it must be rema rked, had t o be rea ched una nimously to reflect t he strong na tionalist

sentiment, especially in France. There was, thus, no big bang toward a federal Europe to the chagrin

of committed federalists. Fr a nce also vetoed the denat iona lization of defense through the E uropeanDefense Community (which wa s ta ken up by the North Atla nt ic Treaty Organizat ion) and t he

European Polit ical Community. Nevertheless, economic integrat ion moved forward with the

elimination of customs duties followed by a postwar recovery of unprecedented rapidity. The period

from 1950 to 1973 is often r eferred to a s The G olden Age. This contra sted w ith th e confusion a nd


12/63



4

trepidat ion t ha t followed t he Treat y of Versa illes t o end World Wa r I . In thr ee decades, integra tion

ha d come to be associat ed with a bounty ha rvest .

On J uly 1987, the Single European Act w a s a pproved by 12 member count ries to crea te

a single sea mless European m a rket to 1992, one tha t w a s to abolish all ba rriers to cross-border

movement of goods, la bor, a nd ca pital. I ts concomita nt conditionthe ha rmonizat ion of rules on

content, labels, and safetycreated such localized furor as to threaten its very mandate. But by

1992, apa rt from a few kinks a nd t he loud protests of the U nited Kingdom (U K), the mission w a s

complete. Despite the turmoil in the EMS in 1992-1993 (see below) brought along partly by the

opening of capital accounts and the momentous unification of Germany, the outlook was ever

upward .

The Maa stricht Treat y in D ecember 1991 cra fted the penultima te a ssa ult on the summ it

of Federa l Eur ope: the single Europea n currency an d th e denat iona lizat ion of money. This ha d

its own unique trajectory, which we discuss below.

2. Precursor of the EMU: The European Monetary System

In 1979, the E EC heads of sta te a nd t he European C ouncil established th e EMS, w hich,

through the Exchange Rate Mechanism (ERM), governed exchange rates in Europe until 31

December 1999. The EMS era can be divided into two: the hard EMS from 1979 to 1993 (see

a lso De G ra uw e 2000) and the soft E MS from 1994 to 1999.

a. Features of the Hard EMS

Ea ch member countr y, in agr eement w ith other members, adopted its excha nge rat es centr a l

parity a gainst every other member country s currency a nd pledged to keep it w ithin a ta rget zone

of + 2.25 percent (6 percent for later entr a nts, such a s Ita ly). In pra ctice, this multila tera lly agr eed

parity wa s a gainst accounting money called the European Currency Unit (ECU ).

The ECU wa s a weighted average of all the member country currencies, i.e., ECU = SQiWi,

where Qi is the fixed unit of is currency in the basket, Wi is the w eight of is currency in the ba sket,

and w here Wi = (Qi/Ei). NowEi = S Ei, jQi, where Ei, j is the bilat eral excha nge rate between i and

member j. Ei is the va lue of the E CU in term s of is currency, which is va ria ble over time (Dorruci

2001).

Alteration of the central parity was allowed, in principle, but required the agreement of

a ll members wh o decide if the a djustment is required by ba lan ce-of-pay ments d isequilibrium.

It inherited t he sna kes Very S hort Term Fin a ncing Fa cility (VSTFF ) to enable members

with weak currencies to borrow from members with strong currencies.When a currency wea kens and tests t he ceiling of the zone aga inst a nother members

currency, both count ries a re expected t o intervene. When t he French fra nc wea kened in 1982 aga inst

the deutschmark, th e French fra nc wa s devalued and t he deutschma rk revalued to keep the French

franc in the EMS (Yergin and Stanislaw 2000).


13/63

5

Ca pital controls were ma inta ined, though ra ther loosely, a nd t ra nsparently (e.g . , taxes

on holdings of foreign currency a ssets). Fra nce and Ita ly ma inta ined restrictions on ca pital mobility.

This limited the play of the impossible trinity. Then, from 1989, capital controls began to be abolished

in th e wa ke of the S ingle European Act of 1987, draft ed to usher a single market in goods, labor,

a nd capital in E urope.

The ta rget zone, with in w hich currencies floa ted, a llow ed some moneta ry policy a utonomy

for individual members.

b. Costs and Benefits

Compared t o the confusion of the la rgely unilat eral excha nge ra te sta bilizat ion of the 1970s,

the ha rd E MS succeeded in its mission to esta blish a zone of moneta ry st a bility in Europe. Bu t

this was partly due to the existence of capital controls.

In time, the deutschmark effectively became the anchor currency of the ERM since the

deutschmark was backed by the strongest economy in Europe and a credible monetary policy thatta rgeted inflat ion. In effect , th e deutschma rk w as independently f loat ing a gainst other ma jor

currencies as dictated by the famous n-1 problem, which states that only (n-1) exchange rates

of n can be fixed (de Gr a uw e 2000). This mean t t ha t if th e deutschma rk a ppreciated a ga inst t he

yen a nd t he dollar, wh ich occurred a fter th e P laza Accord in 1985, other Europea n countries a lso

lost competitivenesspart of the reason was that the other member countries began to suffer

current account deficits, which led to the ERM crisis in 1992-1993. But there were other reasons

for the collapse.

c. Why the Collapse?

The a bolition of ca pita l contr ols by the S ingle European Act a llowed the full force of th e

impossible trinity to bear on t he ERM, w hich then becam e progressively inconsistent. When, a s

a result of Germa n unificat ion, the deutschmark str engthened further a s a response to high Germa n

interest ra tes a nd t he now open ca pita l account , the str a in beca me too heavy in 1992-1993 a nd

the hard EMS collapsed. Italy and the UK were forced out of the EMS in 1992.

German unification and its monetary management (viz., the one-to-one exchange between

the deutschma rk a nd t he os tma rk) forced a fundamenta l f isca l imbala nce tha t could not be

accommodated within t he zone tha t t he init ial pa rit ies a dopted in EMS I . Note tha t t he Germa n

Bundesbank under Ot to Pohl opposed the one- to-one exchange as incompat ible wi th the

B undesba nks role of a nchor currency issuer (Yergin an d S ta nislaw 1998).

The collapse of the hard E MS paved the wa y for soft EMS .

d. Features of the Soft EMS

The aftermath of the 1992-1993 crisis saw the ERM target zone for the remaining countries

w iden to + 15 percent. This beca me known a s the soft ERM.



14/63


15/63

7

c. Exchange Rate Policy

So important was the exchange rate for price stability and competitiveness that the ECB

does not ha ve the sole prerogat ive here. Another body, th e EU Council of Economics an d Fina nce

Ministries determines the Euro exchange ra te regimes, and th e European S ystem of Centra l Ba nks

enforces it, i.e., intervenes directly to implement the policy.

d. The Growth and Stability Pact: Fiscal Policy

Sin ce fisca l irresponsibility ha s in hist ory proven t o be the w a terloo of moneta ry cooperat ion;

fiscal autonomy is also somewhat restricted among members of Euroland. The 1996 Dublin Summit

formulat ed the G rowth a nd S ta bili ty P act , w hich imposed f ines on members with f isca l deficits

exceeding 3 percent of G DP . Specifica lly, a fine of 0.1 percent of G DP is imposed for every 1 percent

in excess of th e 3 percent ceiling. If a member country is in a recession, st rictly defined, t he count ry

is automatically exempt. Thus, the Pact recognizes the Keynesian role of deficit spending inextra ordinary t imes. I t is a lso a r ecognit ion t ha t the Ma ast richt convergence criteria a ppeared

to have successfully induced a zone of stability after the 1992-1993 turmoil. Thus, not only is

moneta ry policy ha nded over to a supra na tional body (EC B ), the very remaining instrum ent w ith

w hich to count er domestic shocks is a lso restricted. This mecha nism w ill ensure fidelity to Mundell-

Flemin g rules (see a lso Section 6.D for more on th e da ngers of overborr owing .)

e. Seigniorage Allocation

Article 32 of the Ma a stricht Treat y spells out t he a llocation seigniora ge: ea ch nat iona l centr a l

bank earns moneta ry income derived from a ssets backing its moneta ry base (these assets a re,

by Article 3, the property of the ECB ). This income is tra nsferred to ECB a nd is rea llocat ed to

the Cent ra l Ba nks in proportion to their capita l sha res in the EC B . The member countrys populat ion

shar e and G DP shar e in Eur olands popula t ion a nd a ggregat e GDP , respect ively, determine the

members capita l sha re in ECB . Thus, th e flow of seigniora ge appears t o be from members th a t

a re rich but w ith sm a ll popula tions to members th a t a re poorer but w ith la rge populat ion. This

acts like a fiscal federalist instrument (Buiter and Siebert 1997).

Since the Euro is envisioned to be a hard currency (i.e., price stability is the rule), the

seigniora ge revenue is bound t o be small a nd so is expected to crea te litt le ra ncor.

4. Democratic Deficit

The ECB s sta tute can be cha nged only w ith a renegotia tion of the pertinent interna tional

treaty. The ECBs independence is unparalleled, so much so that there is no clear mechanism

for checks-and-balance (Eichengreen 1996). The European Parliament has no power to sanction

ECBs decisions beyond calling its officers to report. Thus, it suffers from the criticism that is



16/63



8

usua lly fired a t B russels: democrat ic deficit a nd, thus, legitimacy. B y contra st, th e Bundesban ks

charter can be revoked by t he Germa n par liament, a fact t ha t w eakens the tw in-sister thesis (see,

e.g., Debrun 2001 for a n elabora tion of the tw in-sister view). As long a s the E CB s a ctua tion rema ins

reasonably true to its man dat e a nd as long as tha t ma nda te rema ins valuable to the constituents,

then that itself is the source of its legitimacy (Eichengreen 1996, Weber 1984). What, however,

if it becomes perceived a s unr easona ble? Qu i s custodes custod i t?is the centra l dilemma .

5. Ireland: EMU Outlier and the Catch-Up Phase

The case of the Republic of Ireland (Ireland) is particularly informative as a case of an

economy in a ra pid ca tch-up phase t ha t jumped unto the EMU bandw agon (CE P R B ulletin 2001).

For the last dozen yea rs, Irelands growt h ha s been uninterrupted and output growth ha s hovered

between 7 a nd 11 percent in the last five year s. Already, Ir elands G DP per capita is higher th a n

the U Ks, and la bor shorta ges (3.8 percent unemployment in 1998) ha ve at tra cted migran t w orkers

not only from East Europe but from the UK itself.Poss ible explanat ions for growth abound: f rom being an entrepoteconomy with low

corpora tion tax, w hich a tt ra cts multinat iona ls especia lly from the U S; to low w a ge, highly educa ted

labor force; to the underva lua tion of the Irish punt , which devalued in 1986 a nd a ga in in the ERM

crisis in 1993; to the frenetic public infrastructure program pulled along by a doubling of EU

structural funds associated with the EMS, which peaked at about 3 percent of GDP in 1993. Labor

a bsorption, rat her tha n productivity growth, wa s the result . Ireland w as showing the features

of an Ea st Asian m iracle.

But th is expansion has i t s Eas t Asian dangers in the wake o f the Euro . Recal l that

Ta ipei,China a lwa ys ha d a t ight moneta ry policy to diffuse th is tendency up to the early 1980s.

Ea sy money in the second half created a da ngerous a sset price bubble. Property prices in Ireland

likew ise soa red (20 percent rise in house prices since the EMU sta rt ed), an d CP I infla tion rose

to 6.2 percent, t rebling the EC B s ceiling. Ha d Irelan d ha d moneta ry a utonomy, the interest ra te

w ould ha ve been ja cked up to nip in th e bud the nontra deable sector boom, which tends t o raise

th e overa ll cost of production an d erode competitiveness. Inst ead, on 1 J a nua ry 2000, the interest

ra te in Irelan d fell to Eurolan d level, fueling further th e nontr a deable sector cauldron an d ma king

a h a rd crash eminent. For Ireland, the EMU interest rat e may m ean a misalloca tion of resources

in the catch-up orbit. B ut a soft la nding is not in the ca rds beca use ECB s at tention is all of Eurolan d.

Fiscal inst rument s, such as a budget surplus, now th e focus to effect a soft la nding, is limited if

the private sector takes up the slack. Perhaps real estate targeted capital gains tax used in

Ta ipei,China unt il the mid-1980s ma y help. This is one ar gument a ga inst t a x har monizat ion in

the EMU. There is no question that being in the EMU gave Ireland a sheen it cannot hope toha ve on its own. B ut it ma y a lso ha ve to give up its ra pid growt h orbit in fa vor of the more modest

growt h in E uroland. C onvergence ha s its plus a nd it s minus (see a lso Obstfeld 1998, section 4,

for an excellent discussion).


17/63

9

Whether t he federalist movement displays enough verve to go beyond t he Eu ro depends

ultima tely on th e success of the Eur o experiment. P rogress in Europe ha s a lwa ys displayed a pat h-

dependent trajectory in which past and recent history hugely determine the next steps to undertake.

III. CURRENT EXCHANGE RATE REGIME

AND MONETARY COOPERATION IN EAST ASIA

In this section, we revisit the initial position of our subsequent discussion, namely, the

current exchange rat e and coopera t ive monetar y sta tus q uo in E ast Asia.

A. Features

1. Initial Response

The Asian currency crisis forced m ost Asian crisis economies (In donesia , Republic of Korea

[Korea] Philippines, a nd Tha ilan d) to aba ndon a de fa cto dolla r peg in fa vor, initia lly, of an exchan ge

ra te float . Mala ysia, however, chose to peg a nd S ingapore sta yed wit h a ma na ged floa t. The P eoples

Republic of China retained its fixed peg and Hong Kong, China retained its currency board

a rra ngement (Fischer 2001, IMF 2000). Ma ny observers blam ed the de fa cto dollar peg as one

of the precipitating factors of the crisis when the dollar appreciated heavily in the 1990s. The

overa ll effect of the postcrisis a djustments is grea ter flexibility in excha nge ra te policy.

2. Reversion?

There is some evidence, however, of a reversion of the observed exchange rate policy to

the de facto peg w ith t he recovery. Ka w a i an d Akiya ma (2000) showed tha t in t he precrisis period,

observed excha nge ra tes in Ea st Asia responded sta tist ica lly to movements in one or other a nchor

currency (largely t he U S dolla r), or a bas ket of currencies. During t he crisis, these currencies,

suggesting free float, moved independently of their anchors; but in the postcrisis period, their

movements a ppea r t o once aga in echo the precrisis response. Despite the loud ta lk on in f la t ion

targeting, by consensus a necessary corollary of an independent float, E ast Asian centra l ban kers

st i l l appear to target t he excha nge rate , albeit within a wider band.

3. Forex Reserve Accumulation

The plaus ibility of this r eversion thesis is reinforced by a defensive move in the form of

forex reserve accumulat ion. Table 1 (see Appendix B) shows the extent of forex reserves

accumulat ion to 2000. Countr ies c lass i f ied by the In ternat ional Monetary Fund ( IMF) as

independently floa ting ha ve accelera ted forex accumula tion, an a nomaly if coupled w ith a true

Section IIICurrent Exchange Rate Regime and Monetary Cooperation in East Asia


18/63



10

float. Whether this is a reflection of the Calvo and Reinhart (May 2000) fear of floating or of

the Hausman, Panisa, and Stein (1999) fear of pass through (exchange rate movements being

reflected in domestic prices), it still suggests a dirty float and, apart from the wider band, may

not differ ra dically from t he previous de fa cto peg regime.

4. Cooperative Arrangements

Yet a nother evidence of dirty float is th e eager pa rt icipat ion of these so-called independent

float ers in the Chia ng Ma i Initiat ive, wh ich involves a currency sw ap netw ork a mong the Asean+ 3

(P eoples Republic of China [P RC], J a pan, K orea). Pa rticipa nts facing capita l outflow can q uickly

borrow foreign excha nge for currency defense, from either th e Expan ded ASE AN S wa p Arra ngement

(to provide liquidity in dollar , yen, or euro) or a network of bilateral swap arrangements or

repurcha se (sa le an d buy-back of a ppropriat e securities) agreements a mong th e ASE AN countr ies,

P RC, J a pan, a nd Korea. The ASE AN Sw a p Arra ngement fa cility is now worth $1.0 billion. While

these short-term liquidity facilit ies ar e appropria te for count ries wit h one form or other of a pegsuch a s P RC; Hong Kong, China; Mala ysia, Myanma r, and Viet Na m, they aga in suggest a t best

a dirty float for Indonesia, Korea, Philippines, and Thailand, which report independent float.

The reversion thesis in East Asia reflects the post 1992-1993 European currency crisis exchange

ra te regime, which aba ndoned the har d ER M wit h a + /-2.5 percent ba nd in fa vor of a soft ERM

w ith + /-15%ba nd. There is no question tha t t he overa ll postcrisis Ea st Asia exchange ra te syst em

is closer to t he floa t corner solution a nd less prone t o crisis in view of th e concomita nt reforms.

5. Financial Reforms

Greater transparency and stronger prudential rules for the f inancial market on top of

cooperative capital flow surveillance efforts round up the universe of defensive posturing by East

Asia n count ries. As t hese strengt hen t he most crisis-prone segment of the economy, t hey w ill clear ly

reinforce the economys ability to w ithst a nd sh ocks.

B. Robustness

Only time will tell whether these defensive moves in East Asia will prove more robust

than the precrisis one.

The doubling of petroleum prices in 2000 w a s one shock tha t E a st Asia un der th e curr ent

regime seems to ha ve absorbed wit hout much difficulty. This is clea r evidence tha t t he wider ba nd

an d great er mar ket t olera nce is working.The ASE AN Sw a p Arra ngement a nd bilateral sw ap a rra gements a re importa nt because

w hen real resources are pledged a nd put t o risk, the count erpart is usua lly an implicit contr a ct

to consider uns olicited a dvice from par tners a s t o the seriousness of certa in developments. The

game clearly is: If you ignore early warnings from partners, you run the risk of being denied


19/63

11

the sw a p fa cilities w hen t he crisis comes. This is, h owever, m ore effective clea rly for idiosyncrat ic

shocks brought a bout by interna l misman a gement. Shocks tha t initia lly raise regional buoya ncy

a s did t he portfolio investment in th e 1990s, ma y n ot be as easily recognized even by ma ny pa irs

of eyes. This, nonetheless, reduces t he likelihood tha t one par tner will persistently lean a ga inst

the market wind.

C. Drawbacks

The w eakness of the current Ea st Asia n excha nge ra te regime is still considera ble. This

draws largely from its being a unilateral stabilization regime, albeit reinforced by cooperative

mult ilateral swap and repurchase arrangements:

(i ) Misa l ignment s among t he major cur rencies w i ll s t il l t r ans la t e int o reg iona l rea l

effective exchange rates divergence. Thus, the depreciation of the yen will erode

the competitiveness of the de facto dollar peggers in the region vis--vis the defacto yen peggers. The old conundr um sta ys.

(i i) There i s ample room for beggar-t hy-ne ighbor deva lua t ions as i s normal w i t h

unilatera l excha nge rat e sta bilizat ion regimes. Mora l ha zard ar ises beca use it is

dif ficult t o discriminat e between excha nge ra te a djustment due to fundamenta l

disequi l ibr ium a nd one due t o beggar- thy-neighbor . The only enforcement

mechan ism a t wo rk i s un i l a t e r a l re spo nse , i . e . , l e t t he a f fec t ed par t y t ake

countervailing measures.

(i ii ) Since there is hardly any explici t b inding enforcement mechanism, the swa p and

repurcha se arra ngements ma y induce undue risk-ta king, a charge a lso leveled a t

the IMF.

IV. PROPOSALS FOR MONETARY AND EXCHANGE RATE COOPERATION

IN EAST ASIA

As a n a lterna tive to the current excha nge rat e and m oneta ry st at us quo (i.e., uncoordina ted

de facto pegs w ith w ider ba nds reinforced by swa p a nd r epurchase fa cilities), a number of proposals

for exchange rate management have been proposed. These range from unilateral stabilization

regimes (from one corner solution of uncoordinated free float to the other corner solution of

uncoordinated currency board), to coordinated stabilization culminating with a common currency

for East Asia or subsets of it. In this section, we will ignore the unilateral solutions and will dwellinstead on the regimes characterized by varying levels of coordinat ion. Three proposals are

discussed: William sons common ba sket peg (a lso known a s BB C), th e Asia n Excha nge Rat e

Mechanism, and the Yen Block.

Section IVProposals for Monetary and Exchange Rate Cooperation in East Asia


20/63



12

A. Williamsons Common Basket Peg

B y fa r, th e most developed tra nsitiona l proposa l an d the most comment ed on is Williamsons

common basket peg (Willamson 1999, 2000).

1. Features

(i ) An ex change r a t e reg ime t a rge t ing a common baske t of cur rencies (US do ll a r ,

J a panese yen, and EE Cs Euro).

(ii) A common set of weights at ta ched to these currencies based on regional (not country)

trade shares. Thus, explicit or implicit , and idiosyncrat ic trade-based weights

currently being used will have to be removed.

(i ii ) Ea ch member a nnounces a centra l par i ty v is--vis the basket a nd pledges to keep

the central par ity w ithin a unila terally chosen ba nd.

(iv) The a l lowa nce of a ra nge of formal exchange ra te reg imes such as the currencyboa rd in Hong Kong, China ; the f ixed par ity in Ma laysia ; the cra wl in In donesia;

or various types of managed floating in Korea, Singapore, and Philippines.

(v) Adopt ion o f McKinnons (1989) res tora t ion rule tha t na t ional a uthor i t ies, when

confronted with massive speculative attack, are allowed to temporarily suspend

the peg provided a pledge to return to the original parity is credibly made.

(vi) Since changes in economic fundamentals and basket currency misal ignments are

a fa ct of life, and these impact on member countr y competitiveness, member countr ies

ma y a llow central par ity a nd the band t o cra wl a s a r esponse to these fundamenta l

changes.

(vii) A financing analog to the European VSTFF to help member currencies under at ta ck

from speculators is envisioned.

Dornbusch and P a rk (1999) w ho ca ll Willia msons proposa l the BB C (B a sket, Ba nd, Cra wl)

a grees with it but only on condition tha t it be tra nsitiona l to a more flexible arra ngement. Kaw a i

and Takagi (2001) commend the BBC as a catalyst for greater convergence and exchange rate

sta bility, w hich presumably w ould lead t o a common currency. This wa s the role the EMS pla yed

in the run-up to the Euro. The latter appears to be the more popular view.

Fea tur es (v) and (vi) are clear ly in fluenced by th e EMS crisis experience in 1992-1993 when

exit from the EMS was forced upon some members (Italy and the UK). A de facto return to the

EMS, a lbeit w ith a wider ban d (from + 2.5 to + 15 percent) pa rt ly explained the sta bili ty from

1993 to the end of the EMS era on 31 December 1999.

2. Benefits

(i) The most obvious benefit is the reduction of the intraregional real effective exchange

ra te volatility occa sioned by m isalignments am ong the ma jor currencies. This w a s


21/63

13

blam ed as one source of th e Asian currency crisis; the yen depreciat ed heavily a ga inst

th e US dollar in t he run-up to the crisis. William son (1999) ha s given count erfa ctua l

simulation evidence of reduced volatility under the common basket peg compared

with t he s ta tus quo .

(i i) This proposal wi l l a lso lead to great er overal l s t abi li ty and predicta bi li ty of the

nominalexchange ra tes (wh ich, presumably, businessmen pa y a tt ention t o) of those

countr ies currently pursuing a ma na ged f loat . The lynchpin is rea lly great er

tra nsparency. In the sta tus quo system, nat iona l auth orit ies can ma nipulat e the

weights t o ra m down excha nge ra te changes tha t suit t heir self-serving purposes.

U nder the William son proposa l, cha nges in excha nge rat es unwa rra nted by changes

in th e basket currencies ca n be called to a ccount by member count ries.

(i i i) Thus, there is considera bly less room for beggar-thy-neighbor devalua t ions an d

should focus competition on supply-side effort.

(iv) The latter w ill lead to some convergence in Maa stricht-like and OCA-like conditions

for th e region, which will prepare th e ground for even grea ter regional moneta rycoopera tion. This a nchors Ka w a i a nd Ta ka gis (2001) support for William sons B B C.

(v ) R el a t i v e t o E M S , t h er e is con s id er a b l y l es s n eed f or p ol icy c oor d i na t i o n a n d

surveillance (Ka w a i a nd Ta kagi 2001), wh ere institut ions for this purpose are spa rse.

(v i) This can ha s t en a mo re comple t e commercia l in t eg ra t ion of E as t Asia . In t he

European Economic Community, the EMS coexisted with the Single Market Act

o f 1986, which completed the m a rket in t egrat ion o f th e Eur opean Economic

Community.

(vii) This wi ll s t rengthen Ea st Asia s voice as a negot ia t ing block in the world .

3. Costs

The ma in at tra ction of Williamsons B B C is tha t it calls for no dra stic cha nge in the excha nge

ra te regimes of member countr ies. It only calls for cha nging th e ta rget currency. This la tt er change

ha s three parts : F irst is the shif t of the exchange rat e ta rget to a basket of currencies from the

dollar or wha tever currency w a s previously t a rgeted. Second, th e inclusion of and only of the t hree

major currencies (dollar, yen, Euro). Third, the adoption of a common set of weights.

The first, largely uncontroversial as it is already a reality for Thailand, has been proposed

for Hong Kong, China . Furt hermore, effective, a s opposed to forma l, excha nge ra te ma na gement

shows t ha t a uth orities, even of self-styled free floa ts, do respond t o movements in one or more

ma jor currency (Ka w a i an d Ta ka gi 2001, Ka w a i an d Akiya ma 2000, Fra nkel an d Wei 1993). This

points towa rd w eak potential r esista nce of Ea st Asian centra l bank aut horit ies to this shif t .The second, once the first ha s been hurdled, is a lso rela tively uncontroversia l, since the

statures of these three currencies are unchallenged.

The th ird a spect, t he a doption of a common set of weights, is more contentious beca use

it r eally is t he more cooperat ive fea tur e of th e proposa l a nd spells out the cost. As long a s t he



22/63



14

w eights a tt a ched to th e three curr encies ar e idiosyncra tic, the cost to members is negligible. The

common regiona l weights a tt a ched to the t hree-ba sket currency do involve a rea l sa crifice of na tiona l

sovereignty.

Suppose the yen depreciat es 10 percent a gainst the U S dollar. In a common currency ba sket

tha t gives the yen a 30 percent weight , the wa rra nt ed deprecia tion of domestic currency is 3 percent.

This will be the average depreciation against the yen in the region, which reduces the implied

a ppreciat ion versus the yen. I f the trade sha res of a pa rt icula r country X shows tha t J a pan ha s

a 100 percent sha re a nd a proper weight of 1.0, country Xs currency, if unilat erally sta bilized,

should depreciat e fully by 10 percent if Xs competitiveness a ga inst rival exporters t o J a pan, wh ose

currencies a re pegged t o the U S dolla r, is t o be maint a ined. Thus, X w ill lose competitiveness

w ith only a 3 percent depreciat ion. This na rrow ing of the room t o fully pursue self-int erest is th e

cost of the common basket peg.

Note, however, tha t t he common ba sket does limit t he var ian ce of regiona l excha nge ra te

responses due to a 10 percent yen d epreciat ion. In deed, they a ll cha nge by 3 percent a nd so preserve

cross-regiona l competitiveness. Countr y X ha s t o be convinced th a t this reduction of divergenceamong member exchange rates delivers benefits in excess of those foregone due to the loss of its

ma neuvering room a vaila ble in t he sta tus q uo with idiosyncrat ic weights. Clearly, even in t his

very loose coopera tive a rra ngement a s t he Williamson proposa l, there is no free lunch.

This cost is absent for those countries whose idiosyncratic trade weights resemble the

regions. These countries get th e benefits w ithout t he cost. I t is t he outliers w ho clearly bea r t he

brunt of this cost. Note that this cost is reminiscent, if dwarfed, by the much larger analogous

cost of cooperation under the common currency.

Williamsons BBC does not provide for an administrative arm although there definitely

are coordination issues, such as the restoration rule and the very short-term financing facility.

4. Differences with the EMS

One can view, as do Dornbusch and Park (1999) and Kawai and Takagi (1999) Williamsons

B B C a s a t ra nsitory moneta ry coopera t ive arra ngement leading to a more perma nent moneta ry

union. As such, it a ssumes t he role EMS play ed in the run -up to the E uro. A compa rison is, thus,

in order. The common features are:

(i) a common ta rget ba sket

(ii) a ba n d a r oun d t he cen tr a l pa r it y

(i ii ) a loan fac il ity to a l low quick forex l iquidity to currencies in d is t ress

(iv) a l lowa nce of adjustment in response to fundamental d isequi libria

The differences are considerable:


23/63

15

(i) The band and the centra l par i t ies are col lect ively agreed upon in the EMS, which

is not so in the B B C, w here these are unilat erally determined.

(i i) The E MS a l lowed on ly a t a rget z one ex change r a t e reg ime wit h a f loa t w i t h in t he

zone w hose thresholds a re set by the E MS (2.5 percent a bove or below the centra l

parit y for the ha rd EMS ; 15 percent for the soft EMS ); the BB C a llows a ll excha nge

rate regimes except a float.

(i i i) The composit ion of the common ba sket dif fers: in the EMS, the common basket

consists of member country currencies; in BBC, the basket consists of the major

currencies in th e world.

(iv) The common basket ta rget in the EMS, in practice, became largely the deutschmark.

(v) The Will iamson BB C uses a common reg ional t rade share-based set of weights.

Thus, t he degree of cooperat ion in the E MS is considerably lar ger tha n it would be under

B B C. One may view B B C a s a primit ive EMS t ha t requires less coopera t ion but , nevertheless,

may lead to greater convergence.

B. Asian Exchange Rate Mechanism

This pr oposal of Oh a nd Ha rvie (2001)seeks to replicate E MSs Exchange Ra te Mecha nism

in the Asia n region. Fea tures of the Asian Exchan ge Rat e Mechan ism (AERM) doveta il with those

of the ERM but with notable differences.

1. Features

(i) An Asian Currency Unit (ACU) to doveta i l the European Currency Unit of the EMSis envisioned. The former is a ba sket of Asian member count ry currencies, which

will serve a s a single basket currency ta rget .

(i i) The weigh t s a s s igned t o each coun t ry a re t he t r ade share of t he coun t ry in t o t a l

tra de of the region. This differs from t he weighing sys tem in t he EC U , wh ich involves

an arbitrary quantity of the currency in the basket .

(i ii ) The member country exchange ra tes are to floa t wi th in a band o f 15 percent plus

or minus t he cent ra l parit y just like the post-1993 soft EMS . The cent ra l par ities

ar e not unila terally determined.

(iv) A lender of las t resor t in the form of a quick disburs ing loan fa ci li ty akin to the

EMS VSTFF to w eather speculat ive at t acks.

(v) The centra l par i ty is to be approved by an author i ty, the Asian Monetary Ins t i tute,which is like the Eur opean Monetar y I nstitute, to ma na ge the AERM a nd implement

a greed coordinat ion a nd surveillance policies.

(vi) The target zone exchange ra te reg ime is obliga tory for each country .



24/63



16

2. Benefits

The benefits of AER M a re those as socia ted w ith t he EMS s E RM. Sin ce it involves a closer

coordinat ion t ha n Williamsons B B C, AERMs cooperat ive benefits a re in th e sam e direction a s

B B C but stronger, i .e. :

(i ) reduced in t r a regiona l vola t i l it y o f rea l ef fect ive exchange r a t e s resu lt ing from

intra regiona l parity changes (due, say, to fundam ental shifts) and a greater degree

of co-movement of the intr a regiona l excha nge ra tes

(i i) reduced nomina l vola t i li t y and increased inves t ment r a t e

(iii) less room for beggar-thy-neighbor initiatives using demand side policy instruments

(iv) s t ronger convergence ef fect t ha n w ar ran t ed by Will iamson s B BC

(v ) con du ces t ow a r d f a s t er com m er ci a l in t eg ra t i on i n E A

(v i) a p roven t r ac t record as a t r ans it ion phase t o s ing le cur rency

3. Costs

The individual m ember country costs of AERM a re larger tha n t he BB C w here they ar e

in t he sa me direction. There is a somew ha t d ifferent cost due to th e basket composition:

(i ) The f reedom t o maneuver in AE RM is cur t a i led as in t he BB C, bu t g rea t e r . S ince

the ta rget is now a basket of member countr y currencies; changes in the a lignments

between ma jor currencies, e.g., betw een t he dollar a nd t he Eur o, will not get reflected

in excha nge ra tes of member countr ies.

(i i) I f t he E uro deprecia t es aga ins t t he dol la r by 10 percent bu t not a ga inst t he yen ,

blocs attached to the Euro will gain competitiveness in the US at the expense of

the AERM bloc.

(iii) If the Euro depreciates against the yen by 10 percent , and country X in the AERM

ha s 100 percent of its exports into Europe but its w eight in AERM a nd t he weight

of J a pan in t he Asia n currency un ion (ACU ) is 50 percent, t hen count ry Xs curr ency

will depreciat e aga inst the Eur o by 5 percent or half wha t is wa rra nted by its own

individual tra de sha re.

(iv) I f t he E uro apprecia t es by 10 percen t aga ins t t he US dol la r , and t he yen has 50

percent weight in ACU, country X, w hich exports 90 percent of its t otal t o the U S,

will appreciate by 5 percent, thus, losing competitiveness in the US against dollar-

bloc countries like NAFTA or MERCOSUR.

This reduction in degrees of freedom mu st be tr a ded off a ga inst t he benefits of the AERM.

This could conceivably evolve into a yen block the way the EMS evolved in pract ice into a

deutschma rk block.


25/63

17

4. Practicability

Off-hand, it is clear that Williamsons BBC, which requires looser cooperation, faces a lower

political h urdle th a n t he AER M. With so diverse a set of members (see Section VI for a rund own),

it is ea sier to a gree on a comm on basket of three widely r ecognized ma jor currencies (dollar, y en,

a nd Eur o) ra ther th a n of member country currencies wh ose weights will na tura lly favor the yen.

This could be contentious.1 Since the AERM r equires either a ta rget zone or a fixed rat e system,

current excha nge ra te a rra ngements ma y need to be given up (Hong Kong, China s currency board

w ould be given up if a t a rget zone is ad opted; Korea a nd th e Ph ilippiness ma na ged floa t w ould

ha ve to go if a fixed ra te is ad opted). Gr eat er resista nce by cent ra l ban k au thorities is expected.

C. The Yen Block Proposal

Alth ough less w idely comment ed on, the yen block proposal by Ohno a nd S hirono (1997)

a nd D ornbusch a nd P a rk (1999) would ha ve been the most na tura l for E a st Asia before the collapseof the J a pan ese bubble economy in t he lat e 1980s. The fat e of the yen block ha s dimmed w ith

the persistent problems of the J a panese economy but ma y st ill revive depending on the outcome

of the Koizumi reforms progra m in J a pan . This is actua lly closer to the EMS in the la te 1980s

wit h th e deutschma rk a s effective anchor. Thus, its importa nce is tha t t he Asian Moneta ry S ystem,

if implemented, ma y st umble into the y en bloc regime.

1. Features

A peg or a target zone regime may be envisioned with the yen as the anchor currency,

similar to the EMS in the late 1980s when the deutschmark became the effective anchor of the

ER M. Other fea tures of EMS , such a s the EMI -type coordina tion and sur veilla nce body a nd th e

establishment of the initial central parity cooperatively agreed on, would also be present.

2. Benefits

These are simila r t o those of the E MS a nd could clea rly be str onger t ha n t hose of the Asian

EMS . The yen bloc could also be the stea dy sta te stru cture of the lat ter. B ut t he actua l benefits

depend on how the J a pan ese economy performs an d especia lly on how open a nd robust t he J a pan ese

fina ncial sector becomes. The slow pa ce of fina ncial reform a nd th e limbo-like sta te of th e J a pa nese

economy a re th e principa l st umbling blocks.

1 UK P rime Minis ter Ca llagha n regarded the EMS plan in J uly 1978 as a n act of German self-interest thinly

disguised by a veil of self-interest (Dyson 1994, 102).



26/63



18

3. Costs

The principal cost of a yen block vis--vis the Williamson proposal is that misalignments

among major currencies will reflect on the competitiveness of East Asian member countries. The

appreciation of the yen against the US dollar would erode East Asias competitiveness against

the dollar block countr ies, such a s MER COS U R or NAFTA. B ut su ch misalignment s w ill not a ffect

intery en block competit iveness, thus preserving t he intr a block competit iveness riva lry for supply

side instruments.

The cost w i l l be d i f ferent for d i f ferent groups of members in the block. Korea a nd

Taipei,China compete heavily w ith J a pan in th ird ma rkets while importing heavily intermediate

inputs from J a pan. An appreciat ion of the yen will hurt K orea a nd Ta ipei,China less in third ma rkets

such as the U S, since the price of J a pan s exports w ill also rise. Thus, th ose count ries tha t compete

heavi lywith J apa n a re less affected by ma jor currency misalignments.

Countries whose trade rivals are in dollar blocks will lose market share. The PRC is a

prime example of this latter group. The opposite will be true if the yen depreciates. Thus, thevolat ility of the anchor currency in the block and it s genera l drift determines who a mong the yen

block countries ga in or lose. The deutschma rk functioned w ell as the effective a nchor for t he E MS

in the 1980s beca use it wa s very sta ble. However, it a lso hurt the competitiveness and via bility

of other EMS count ries wh en it beca me very st rong in t he run -up to th e 1992-1993 EMS crisis

(the deutschma rk a ppreciated 17 percent a ga inst t he dollar betw een Ma rch a nd S eptember 1992).

4. Practicability

The viabilit y of the yen block proposa l ha ngs not only on the performa nce of the J a pan ese

economy a nd t he concomita nt r estructuring of the J a panese finan cia l sector but a lso on political

considera tions. J ust a s the EMS wa s opposed by some as t he lynchpin to boost the domina nce

of the deutschm a rk a nd G erma ny, so will the yen block revive memories of the imperialist ic Asia -

J a pan Co-P rosperity Sphere of the 1940s. The P RC w ill most likely pose the st rongest political

obsta c le to the yen block. Korea , w i th t he prospect o f uni f ica t ion , ma y a lso ba lk , a l th ough

economically, i t ma y ga in. Tha t the yen w as, in pract ice, l ight ly t a rgeted a s a n a nchor despite

the economic w eight of J a pan in th e region indicated a r evea led a version, alt hough this ma y

be due to historical inertia.

D. Evaluation

It could be expected tha t the d egree of political d ifficulty w ill be directly proportiona l tothe d epth of coopera tion embodied in t he moneta ry integra tion. This is because t he deeper th e

moneta ry int egrat ion, th e more extensive is the sacrifice of na tional sovereignty. In contra st, t he

extent of the economic benefit is directly proportional to the depth of cooperation. This is the

fundamental trade-off that confronts the membership of a proposed monetary integration.


27/63

19

The lea st politically difficult t ra nsitory a rra ngement beyond the sta tus q uo is Williamsons

BBC. The most beneficialin terms of economic benefitis the AERM.

The European st ra tegy to resolve the conflict is to craw l towa rd th e EMU a nd let event s

decide the next step. Even for Europe with all its advantages (see Section VI), a big bang with

all its attendant uncertainties would not have been feasible. As long as the vision is kept alive

by tangible successes, a crawl to the AMU may be the better part of wisdom.

Whatever the degree of monetary integration, its robustness depends upon its capacity

to a bsorb ma rket pressures. Market pressures, on the other ha nd, grow in proportion to the extent

of inconsistency of the a rra ngement w ith Mundell-Fleming imperat ives. At the m oment, t he

proposed arr a ngements a re still a t th a t st a ge where no explicit mechanisms t o sa feguard Mundell-

Fleming consistency a re proposed. There a re no mechan isms t o limit t he fina ncing of deficits by

monetary expansion.

V. COSTS AND BENEFITS OF A MONETARY UNION IN EAST ASIA

This section dw ells first on the considerable evidence on E a st Asia a s a n OC A, w hich suggests

the costs and benefits of a currency union. We then summarize in detail how the benefits and

costs w ill be realized.

A. The Evidence on Economic Feasibility

The case for a currency union in East Asia on purely economic grounds alone appears

favora ble an d hea vily documented, a s w ill be shown below . The economic (OCA) criteria a re better

or worse served depending on t he membership. J a pan; K orea ; an d Ta ipei,China form a favora ble

common currency a xis. The ASE AN, a s a w hole, does bett er in t he OCA sense tha n Mercosur or

NAFTA but slightly worse tha n pa rticula r subsets such a s H ong Kong, China ; Indonesia; Singa pore;

Tha iland (Eichengreen a nd B a youmi 1999) and t he EU . The Asean+ 3 suffers from la rge var iance

in development levels, financial structures, and economic sizes. Appendix Tables 2, 3, and 4

summa rize the evidence on E ast Asia a s a n OCA.

The OCA criteria a re grouped int o three cat egories (see, e.g., Ba rro 2001, B a youmi a nd

Mauro 1999, Mundell, 1961):

(i) Benef it s f rom a currency union are in ferred from the importance and composit ion

of intra regiona l tra de. The great er the importa nce of tra de with in the region, the

lar ger is t he benefit from a bolition of multiple currency-relat ed tra nsa ctions costsconsisting lar gely of currency exchange a nd currency r isk-relat ed cost.

(i i) Cos t s of a currency union a re sugges t ed by t he asymm etr y of macroeconom ic shocks

affecting the economies of the region. A currency union implies a surrender of

monetary policy by an economy whose idiosyncrat ic shocks can no longer be

Section VCosts and Benefits of a Monetary Union in East Asia


28/63



20

a ddressed using monetar y inst rument s. These likely costs ca n be mitiga ted by high

factor mobility. The pain from a n idiosyncrat ic income slump in one a rea is mitiga ted

by the shif t of workers from tha t a rea.

(i ii ) Costs and benef it s can a lso be g leaned f rom the s imilar i ty o f potent ia l members

in levels of economic development, q ua lity of finan cial sectors, a nd m a croeconomic

a nd ideologica l postures. Clea rly, th e cost of integrat ion fa lls the more similar the

count ries a re in th ese dimensions.

1. Shock Symmetry and Response

The methodology here mostly follows Blanchard and Quahs (1989) structural vector auto

regression model. This involves identifying disturbances in output as either demand (temporary)

or supply (permanent) shocks using t ime series of output and prices. Three OCA relevant

mea surements fa ll out of the exercise: size of shocks, speed of a djustment to th ese shocks, and

correlation of these shocks (see Appendix B, Table 2). Eichengreen and Bayoumi (1999) reportthe following findings for EA-9 for the period 1972-1989:

(i ) Aggrega t e supp ly shocks a re abou t t he s ame s iz e in E urope as in E as t As ia ;

(i i) Aggrega t e demand shocks a re abou t t w ice as la rge in E urope as in E as t As ia ;

(i ii ) The impulse response analys is shows t he speed o f adjustment t o shocks in Eas t

Asia to a bout tw o year s, which is tw ice as fa st a s in Europe. Ja pan; H ong Kong,

China ; and Ta ipei,China a re the fastest a djusters while the Philippines is the slow est.

This could be due to greater labor market flexibility in East Asia.

(iv) Demand shocks in Hong Kong, China; Indonesia; Malaysia; Singapore; and Thailand

ar e highly correlated, as ar e those of J apa n; Korea; a nd Taipei,China.

(v) J apan ; Korea ; and Taipei ,China form one subgroup with h ighly correla ted supply

shocks. Hong Kong, China ; Indonesia ; Mala ysia ; an d Singa pore comprise another

subgroup wit h high supply shock correlat ion. In contr a st, t he P hilippines a ppea rs

to be a complete outsider, as do Ireland and Portugal.

(v i) E s t ima t ed O CA ind ices (pred ict ed leve l of b il a t e r a l exchange r a t e va r i ab i l it y

expla ined by four OCA proxies, viz., rea l output, differences, sector sh a re differences,

bilatera l export ra tios a nd G DP difference) for Singa pore-Tha iland; Singa pore-Hong

Kong, China; Singapore-Taipei,China; and Hong Kong, China-Taipei,China are very

low a nd a re within t he Eurolan d league. This means th a t a n externa l peg for these

tandems would not harm. Indonesia , Korea , and Phi l ippines are not c lose ly

integrated by the OCA index used.

B a youmi a nd Eichengreen (1996) construct OCA indices for E a st Asia n countries vis- -

vis J apa n, G ermany, U S, a nd the Williamson B asket . They show tha t t he OCA indices of Ea st

Asian countries against the Williamson Basket are comparatively low (suggesting that pegging


29/63

21

to the Williamson B a sket will not ha rm a s a ga inst pegging to the dolla r, euro, or yen. Singa pore

and Hong Kong, China would, however, prefer to peg to the US dollar.

Kawai and Takagi (2001) examine the response of GDP to changes in the real effective

exchange rate for East Asian countries. For noncrisis countries (PRC; Hong Kong, China; Singapore;

a nd Taipei,China ) G DP initially increa ses with a real deprecia tion. In contra st, in crisis countries

(Indonesia, Korea, Philippines, and Thailand), GDP initially falls for the full sample for 1970-

1998. If the crisis yea rs 1997-1998 are left out, t he nega tive response of GD P disa ppea rs even

in crisis count ries, except a ga in in the P hilippines. The initia l response diminished over time.

P rices tend t o rise wit h a depreciat ion dur ing th e precrisis period. Thus, in E a st Asian economies,

real output a nd prices respond significantly to changes in the rea l effective excha nge ra te. Thus,

a scheme tha t st a bilizes the rea l effective exchange ra te will help ensure ma croeconomic sta bility.

B ena ssy-Quere (1999), follow ing B a youmi a nd Eichengreen (1996), regressed bila tera l

exchange ra tes aga inst th e yen; dollar; deutschma rk; and t hree OCA criteria (output varia bility,

export similar ity, a nd intensity of bilat eral t r ade) and showed tha t t he f irst ha d posit ive, wh ile

the second and t hird ha d negat ive signs. Thus, output shocks lea d to higher volat ility a nd tr a deintegration leads to less.

P lummer (2001) shows a high cross correla tion among Ea st Asia n G DP , and t hus, shock

symmetry is present .

2. Intraregional Trade

a. Trade Intensity

Goto and Hamada (1994) investigated the degree of interdependence among East Asian

count ries in 1990 via tr a de and factor mobility. The estima ted indices of tra de intensity m easuring

the strength of bilat eral tra de betw een tw o countries were very high for many pairs. In pa rticular ,

J apa ns tra de intensity with Ea st Asian pa rtners wa s high a nd in excess of G ermanys w ith some

Euroland partners (see Appendix B, Table 2).

Ka wa i a nd Taka gi (2001) used 1995 dat a to confirm G oto and Ha ma da. Countries in t he

continenta l Asean (Cambodia, La os, Tha iland, Viet Na m) as w ell a s the P RC an d H ong Kong,

Chin a , ar e highly interdependent (tra de intensity ind ex of 5 or better). J a pan continues to be

extremely important for East Asia and even proves more important in East Asian trade than

G erma ny in E uroland (see Appendix B , Ta ble 2).

b. Exports and Imports

Ka wa i an d Ta kagi (2001) show th a t E a st Asia s tra de with itself is 37 percent of total t ra de;

plus J a pan is up to 45.0 percent. Im port s to itself is 34.6 percent of tota l import s; plus J a pan is

49.4 percent. All these are very high. By contrast, ASEAN exports to itself is only 22.1 percent

a nd imports to itself is 18 percent of tota l. The US , J a pan , an d EU ta ke up 19.1, 15.4, a nd 15.2



30/63



22

percent sha re, respectively, of ASE ANs t ota l tr a de; a nd 20.7, 12.9, a nd 14.5 percent, respectively,

of East Asia-14s tota l tra de. The lat ter suggests t ha t a peg to a basket of three major currencies

for E a st Asia-14 makes sense.

B a youmi an d Ma uro (1999), focusing only on ASE AN (w hich is less int egrat ed tha n E a st

Asia-14 by intra regiona l tra de), showed tha t t he regions regiona l tra de as sha re of regiona l GD P

is high and similar to Europes (11.7 vs. 12.8 percent for exports and 11.8 vs. 12.0 percent for

imports ; see Appendix B , Ta ble 2). Compa ra ble MERC OSU R figures a re 2.1 percent for exports

a nd 2.3 percent for imports, w hile NAFTA figures a re 5.3 percent for export s a nd 5.4 percent for

imports. The share of manufacturing in total exports and imports are about 80 percent in both

cases, higher than MERCOSUR (50 percent). This means a highly diversified trade structure.

As shown by Ka wa i and Taka gi, ASE AN, being highly dependent on US, J apa n, an d Europe as

trade partners, is vulnerable to fluctuations in major currencies.

P lummer (2001) report s a very h igh correla tion coefficient for some E a st Asia n exports

for certa in E a st Asian countr ies. Ma laysia a nd S ingapore exports exhibit a correlat ion coefficient

of 0.6. The Philippines and Indonesian exports, in contrast, do not correlate highly with thoseof its neighbors.

3. Factor Mobility

G oto and Ha ma da (1994) report on the extent of foreign la bor employment in developed

Ea st Asia (see Ta ble 2, Appendix B ). In Sin ga pore in t he 1980s, a bout 10 percent of employment

were w orkers from In donesia, Ma laysia , P hilippines, an d Tha iland. F oreign labor in Hong Kong,

China is also very substantial. Caution has to be exercised on this score. Most of foreign labor

presence is due to labor contra cts wit h very definite entry a nd exit specificat ions w ith ha rdly a ny

free movement a t a ll, much like Turkish w orkers in West G erma ny a nd North Viet Na mese workers

in Eas t G ermany or B angladeshis in Kuwai t .

Ka wa i a nd Ta ka gi (2001) report tha t in Ea st Asia-14, 11, 10, a nd 9 percent of tota l foreign

direct investment (FD I) into in 1990-1998 ca me from J a pan, U S, a nd Eur ope, respectively. Over

40 percent, however, came from E a st Asia it self. Moon et a l. (2000) report tha t E a st Asias FDI /

GNP of 1.75 percent exceeds that of EU (1.59 percent).

4. Maastricht Convergence Criteria

Oh and Harvie (2001) report that in terms of performance of East Asian countries against

the Maastricht criteria, East Asia does as well as Europe on the fiscal criteria but poorly in monetary

criteria (prices and interest rates).


31/63

23

5. Levels of Economic and Financial Development, Size,

and Ideological Leanings

On t hese dimensions, E a st Asia scores very poorly rela tive t o Eur ope (see Ta ble 3, Appendix

B). This is discussed more lengthily in Section VI.

B. Common Currency for Asean+3

Abstra cting from t he difficulties tha t norma lly at tend t he realizat ion of a common currency

(see Eichengreen 1996, a nd E ichengreen a nd B a youmi 1999), w e leapfrog t o a point wh ere there

a lready is a common currency (th e Orienta l hereafter) in Asea n+ 3. The institut iona l underpinnings

of the Orienta l could be:

(i ) An As ian Cen t r a l Bank wi t h a monopoly of monet a ry pol icy for t he reg ion .

(ii) An Asian EMI-type governance institution w ith monitoring/surveillance and a dvisoryroles on member ma croeconomic situa tions w ith a limited (fiscal federa list) budget

a s its enforcement m echa nism. This body determines the claim of a countr y going

through a n idiosyncrat ic shock to the adjustment budget a nd repayments.

(i ii) A polit ical commitment of remarka ble depth that wa s presumably tested along the

way to currency unification.

(iv) A start ing point that is the sta tus quo, i.e. , de facto peg to the US dollar w ith much

wider bands supported by higher reserves (Park 2001) and by CMI instruments,

i .e ., ASEAN Swa p Arrangement an d bilat eral swa p arra ngements (see Kaw ai a nd

Ta ka gi 2001 on possible postcrisis reversion; a lso McKinn on 2000).

(v) A t rue f loa t v i s--v is ot her major cur rencies .

(vi) A more or less completed commercial integrat ion tha t served as a springboar d for

the currency union.

(v ii ) F u ll y open ca p it a l a ccou nt .

(v ii i) An Asean+ 3 t ha t i s a cus t oms union .

These are but severa l sets of instit utiona l support. One can not discuss the costs a nd benefits

of a currency union in an inst itut ional vacuum. Currency unions as a historical outcome are

necessarily pat h depend ent.

1. Benefits

In a currency union, intra regiona l exchange ra te insta bility, which is possible with in the

current de facto peg, w ill cease a nd reduce tra nsa ction cost. Specifica lly th e forw ar d (intrar egional

currency) ma rket premium will disappea r. This will ra ise the relat ive a dva nta ge of intra regiona l

tra de aga inst cross-regiona l tra de.



32/63



24

The transaction cost associated with intraregional currency shifts will disappear, reinforcing

the demise of the intra regiona l currency fut ures ma rket. This w ill serve like the ta riff reduction

in a preferential t ra ding arr a ngement a nd w ill be trade-creat ing. It ma y a lso well be tra de-diverting

as members take up trade previously done with outsiders.

The a bove tw o conditions w ill contr ibute to th e welfa re ga in of member countr ies (B a youmi

1994), especia lly since ASE AN+ 3 is very open a nd ha s a lar ge externa l sector.

The likelihood of a currency crisis w ill fall rela tive to th a t in the current de facto dolla r

peg. First, t he likelihood of currency misa lignment is r educed since the Orienta l is a floa t vis- -

vis other major currencies. Second intraregional beggar-thy-neighbor moves will disappear as an

option. This is importa nt, since price and output response to cha nge in excha nge ra te is considera ble

(Ka wa i a nd Ta kagi 2001) a nd t he tempta tion to shirk is high. Third, intra regiona l misalignment,

w hich is still possible in the current de facto peg, will cea se to exist. Thus, int ra region-origina ted

currency conta gion cea ses.

With grea ter regiona l monetary a nd excha nge ra te sta bility, the region becomes more

a tt ra ctive to FD I (Bena ssy-Quere et a l. 1999). There will likely be a reconfigura tion of FDI sh a rescompared to the sta tus quo. Currently, the P RC, with t he lar gest ma rket and str ongest growt h

potent ia l, gets most of the FD I going int o the region ($20 billion by J uly 2001). ASE AN, incont ra st,

w ill suffer a net loss of FD I in 2001 (Ha noi Ministers Conference Commun ique 2001). A currency

union will serve to bolster t he sta tus of the wea ker members of the union in the eyes of the w orld,

especially a s commercial int egrat ion sh a ll ha ve occurred. Thus, t he currency union w ill confer

a reflected attractiveness to weaker members. This will raise the share of weaker members in

tota l FD I entering t he region. The da mpening effect t o the reflected a tt ra ctiveness is the qua lity

of infrastructure in the weaker members. No fiscal transfers for infrastructure upgrade, as happened

in E urope, a re envisioned.

The presence of a n inst itut iona l infra str ucture designed to support t he Orienta l, ACB , an d

Asian Moneta ry In stitute w ill have a kn ock-on effecton ma croeconomic an d fina ncial performa nce

of weaker members leading toward quicker assimilation of and a convergence to best practice,

especially in the all-important financial sector and in the fiscal sector . This will, on one hand,

strengthen the monetary union (which improves with some macroeconomic coordination) and, on

the o ther , improves t he growth prospects o f the m oneta r i ly w eaker members . E ndogenous

convergence of OCA criteria will be served (Frankel and Rose 1998, Rose 2000).

We suspect (as does Madhur 2001) that the benefits of a currency union in EA could be

grossly underestimated due to a lack of proper appreciation of endogenous OCA convergence. Rose

(2000) shows, using a gravity model, that intraregional trade rises by 300 percent with the

introduction of a currency union. There should also be a convergence toward shock symmetry

(Fra nkel and Rose 1996). Da nth ine et a l. (2001) report t ha t on a lmost a ll counts, th e EMU ha sa lrea dy a ltered the f inancial la ndsca pe of the Euro zone as t ra nsact ions cost a nd liquidity r isk

fa ll. Thus, benefits cannot be properly glea ned only from t he current a rra ngement because dra stic

policy cha nges tend t o cha nge behavior substa ntia lly. A ca se in point is how t he Socialist relance

in Fra nce wa s given up in fa vor of sta ying w ith t he EMS (see Appendix C for an extended discussion

of the relation between economic progra m a nd excha nge ra te regime). How the la bor ma rket w ill

a djust rema ins a n open q uestion (B uti 2001).


33/63

25

The political w ill and cohesion a ssociat ed wit h engendering t he U nion will surely be brought

to bear on th e world politica l sta ge. Fora such as WTO, IMF, a nd World B a nk, will feel the st rength

of a stronger East Asiathat is, if they can find enough common ground to defend.

Members with the least credible monetary policy (and, therefore, the least effective as

instrum ent of policy) will gain t he most. They a re giving up something t hey do not a lready ha ve.

This clearly is happening to Italy in the case of the Euro.

Overa ll inflation will fa ll in the region (Ghosh et a l. 1997) a nd investment ma y be higher.

This ma y, however, reduce the incentive to pursue labor ma rket reforms (Sibert a nd S utherla nd

2000, Cukierman and Lippi 2001).

2. Costs

The loss of monetary autonomy means that the East Asian export-led catch-up strategy

(see Fabella 2000), which worked for East Asia very well before the 1990sa dollar peg with

persistent currency underva luat ion, fina ncial ma rket subject to stat e direction, less tha n completecapita l a ccount openingis no longer a n option for t he la gging m embers of the union. Tha t lesson

of history, which the P RC is st ill trying to follow, w ill cease as a n option. This is rela ted to Ka wa i

a nd Ta kagis (2001) multiple objectives of exchan ge ra te policy. In par ticular, ra pid growt h m a y

have to be given up in favor of average growth.

The great diversity of the membership could pose the biggest problem (Kawai and Takagi

2001; see a lso Section VI.B for a fuller treat ment). A member w ith a tra dition of ha rd a nd credible

fiscal and monetary policy may be tempted to bolt to accelerate its own catch-up process a l East

Asia n model, seeing tha t t he Union is, any wa y, fully open to tra de. It can, a s an outsider, conceiva bly

employ a beggar-thy-neighbor exchange rate policy against the union, which cannot reply in kind

beca use it h a s t o ca ter t o the dema nds of a very diverse group. Of course, focused counterva iling

ta riffs (as long a s WTO-sa nctioned) could st ill be imposed on exports of excha nge ra te preda tors.

This could be tricky if the preda tor competes heavily w ith one member, sa y Tha ilan d, a nd buys

heavily from a nother, say , J a pan . This decision to join a lso ha ngs on the eventua l fat e of EMU

outsiders, e.g., Norwa y, Sw eden, a nd U K. P otential m embers ma y th us exercise the opt-out option,

which clearly ha s va lue under uncerta inty.

The Colignon effect (Colignon 1999) w ill kick in: a s int ra regional excha nge ra te volat ility

expires, interbloc volat ility w ill rise. This is due t o the a djustment burden being car ried only by

one price (the common currency), instea d of by ma ny. Thus, t he tr a nsa ction cost a ssociat ed w ith

a volatile exchange rate will rise in intrabloc trade. This will have a further trade-diverting effect.

The Bayoumi effect (Bayoumi 1994) will also kick in. While member countries are likely

to gain due to reduction in transactions cost, economies outside the union will suffer a welfareloss due to a negat ive output effect coming from possible reduced wage f lexibili ty (see also

Cukierman and Lippi 2001, Grner and Hefeber 1999). This reinforces the Collignon effect: volatility

rises in their exchange rates. This, of course, is one motive to become a member of the union,

and a threat to potential bolters. ( I t also explains Australia and New Zealands unease with

Asean+ 3).

Section VINoneconomic Hurdles and Pursuit Architecture for Asias Monetary Union


34/63



26

Again, the diversity of the membership can work aga inst i t . J a pan is a lrea dy the second

la rgest economy in t he world a nd sh ould be expected t o dema nd a disproportionat e role. The P RC

w ill conceivably be th e lar gest economy in t he world by 2020 if it cont inues to grow a t t he current

rate, and should be accordingly accommodated. At given union exchange rate, reflecting the average

competit iveness, Myan ma r m a y be ha ving a huge current a ccount deficit , w hich it can a ddress

only w ith f iscal a usterity. Since f iscal federalism is slight or a bsent , Mya nma r ma y ha ve to go

into a deep recession with dire polit ical consequences, leading to temporary suspension of

membership. Thus, t he economic diversity of the currency-unified region st a nds in t he w a y of

its sustaina bili ty even a s i t s ta nds in the w ay of i ts realizat ion in t he f irst place. J ust a s in every

countr y w ith political int egrat ion, a n opt-out option ma y be exercised by a province or r egion w hen

the political t hresholds ar e breached, so will it be more readily exercised in a currency union w ithout

political integration.

The issue of diversity in economic development a nd fina ncial sector diversity a rgues for

a t w o-speed or thr ee-speed moneta ry integra tion with, perha ps, Hong Kong, Chin a ; J a pan ; Korea ;

Singa pore; a nd Ta ipei,China on the first OCA boa t (see also Section VI.C).

VI. NONECONOMIC HURDLES AND PURSUIT ARCHITECTURE

FOR ASIAS MONETARY UNION

This section compares the advantages of Euroland over East Asia and suggests features

of a possible pursuit a rchitectur e.

A. Eurolands Undue Advantages

1. Integrationism vs. Nationalism

Whether t he Eur opean Moneta ry U nion will prosper or founder now becomes one of th e

most intriguing political and economic questions of the first decade of the new century. The Gold

St an dar d, at the peak of its hegemony at t he daw n of the last century, brea thed its last before

tw o decades wa s up. The EMU will decide the bat t le betw een t he integrat ionist t ra dit ion a nd

na tionalism. It is the lat ter complexed w ith imperialism th a t ma ny believe produced the Fra nco-

P russ ia n Wa r in 1870, the Russo-J a pan ese Wa r in 1904, the First World Wa r, th e Second World

War, and countless other wars that mocked the achievements of the 20t h century. This was the

credo of the famous Ventotene Mani festoa uth ored by one of the fa thers of Europea n federalism,

Altiero Spignelli (Yergin a nd S ta nislaw 1998). The increasing surrender of na tional sovereigntyto global cooperative endeavoursinherent in the denationalization of money in the EMU and

deeper inroads of WTOwill, if it proves robust, distinguish the 21st from the 20t h century.


35/63

27

2. War

The EMU is historically unparalleled in that it seeks a monetary union in the absence

of a political union among countries that have a proven record of economic success. Monetary

union in the U S ca me only in 1788 a fter political un ion ha d been cemented. Moneta ry un ion in

Germany came only in 1871 after Germany had thrashed France and long after the Zollverein

got going in t he 1830s. It a lys moneta ry u nifica tion came only in 1893 aft er its political int egrat ion

in 1861 (Eichengreen 1996). And some currency unions could not survive political disint egra tion,

e.g . , the Russian ruble area.

A funda menta l reason, observes Goodha rt (1995), wh y sta tes cling t enaciously to monetar y

aut onomy is wa r . If w a r betw een distinct na tion-sta tes is inevita ble, then th e power t o print m oney

a nd t he resulting seigniora ge it confers is crucial. It is, aft er all, th e revenue of last resort (Goodha rt

1995). Political integration dissolves the nation-states and reduces the likelihood of war (the

Ventotene Manifesto thesis) . I t also improves the prospect of a f iscal federalist solut ion to

idiosyncratic shocks, of which border wars are an example. Thus, monetary autonomy is morereadily given up after political integration, rather than before.

Eur opean int egrat ion ha s alw a ys dra w n strength from one overa rching political enterprise:

ma inta ining Europe as a zone of peace. This wa s J ean Monnets a nswer t o the enduring G erman

monetary cooperation in east asia: a survey

Documents