Exchange Rates under the East Asian Dollar Standard: Living with Conflicted Virtue

292 Pages·2005·3.42 MB·English

by  Ronald I. McKinnon

46956Mckinnon 1/19/05 1:26 PM Page 1
economics/finance
Ronald I. McKinnon is William D. Eberle Professor of “This book is timely and impressive. It synthesizes McKinnon’s work on the nature and
International Economics at Stanford University. He is the effects of the exchange-rate policies pursued by the East Asian countries. You may not
author of several books on international economics and agree fully with his policy conclusions, but you cannot ignore the arguments and evi-
development finance, including The Rules of the Game: dence assembled in this volume.”
International Money and Exchange Rates (MIT Press, —Peter B. Kenen, Professor of Economics, Emeritus, Princeton University, and
1996) and, with Kenichi Ohno, Dollar and Yen: Resolving Council on Foreign Relations
Economic Conflict between the United States and Japan Exchange Rates
(MIT Press, 1997). “McKinnon argues persuasively that the ongoing efforts of American analysts and politi- under the
cians to urge Japan, China, and other Asian countries to appreciate their currencies
East Asian Dollar Standard
against the dollar is fundamentally misguided—indeed, it would unnecessarily damage
those countries and the world economy. Necessary corrective reading for all enthusiasts living with conflicted virtue
of floating exchange rates.” Ronald I. McKinnon
—Richard N. Cooper, Boas Profesor of International Economics, Harvard University Exchange Rates
The increasingly integrated economies of East Asia—
under the China, Hong Kong, Indonesia, Japan, Korea, Malaysia,
the Philippines, Singapore, Taiwan, and Thailand—face the
East Asian Dollar Standard dilemma of how to achieve exchange-rate security in the
absence of a unifying “Asian euro.” The U.S. dollar has
become the region’s dominant intraregional trading cur-
rency as well as the monetary anchor to which East Asian
economies informally peg their currencies. In this timely
living with conflicted virtue and original analysis of the benefits and risks of an East
Asian dollar standard, Ronald McKinnon takes issue with
the conventional view that urges flexible exchange rates on
financially fragile economies. He argues instead that East
Asian countries should coordinate their policies to keep
their exchange rates stable against the dollar.
McKinnon develops a conceptual framework to show
where the conventional wisdom on exchange rates has
gone wrong. Pressure on the “virtuous” high-saving dollar-
creditor East Asian nations to appreciate their currencies
the mit press leads to a “conflicted” choice between a possible deflationary
Massachusetts Institute of Technology slump if they do appreciate and threatened trade sanctions
Cambridge, Massachusetts 02142 if they do not. Analyzing interactions among the East Asian
http://mitpress.mit.edu economies, McKinnon explains the rationale, and the need,
for greater exchange-rate security in the region, pointing to
the soft-dollar pegs adopted by these nations as steps in the
0-262-13451-9
right direction. He suggests that the dollar standard in East
,!7IA2G2-bdefbe!:t;K;k;K;k Asia could be rationalized through collective action by
national governments and considers the effect of American
monetary and trade policies on the East Asian economy.
Ronald I. McKinnon
Exchange Rates under the East Asian Dollar Standard mckinnon
Exchange Rates under the
East Asian Dollar Standard
Exchange Rates under the
East Asian Dollar Standard
Living with Conflicted
Virtue
Ronald I. McKinnon
The MIT Press
Cambridge, Massachusetts
London, England
( 2005 Massachusetts Institute of Technology
All rights reserved. No part of this book may be reproduced in any form by any elec-
tronic or mechanical means (including photocopying, recording, or information storage
and retrieval) without permission in writing from the publisher.
MIT Press books may be purchased at special quantity discounts for business or sales
promotional use. For information, please e-mail
To my seven beloved granddaughters:
Katy, Aly, Savannah, Alexandra, Charlotte, Emily, and Natalie
Contents
Preface ix
Introduction: The East Asian Exchange Rate Dilemma 1
1 The East Asian Dollar Standard, Fear of Floating, and Original
Sin 13
with Gu¨nther Schnabl
2 Synchronized Business Cycles in East Asia, and Fluctuations in
the Yen/Dollar Exchange Rate 53
with Gu¨nther Schnabl
3 Japan’s Deflation and the Syndrome of the Ever-Higher Yen,
1971–1995 77
with Kenichi Ohno
4 Japan’s Negative Risk Premium in Interest Rates: The Liquidity
Trap and Fall in Bank Lending 103
with Rishi Goyal
5 China: A Stabilizing or Deflationary Influence in East Asia? The
Problem of Conflicted Virtue 129
with Gu¨nther Schnabl
6 The Overborrowing Syndrome and Economic Liberalization 165
with Huw Pill
viii Contents
7 Optimum Currency Areas and Key Currencies: Mundell I versus
Mundell II 199
8 Rationalizing the Dollar Standard in East Asia: Living with
Conflicted Virtue 227
Notes 251
References 257
Index 265
Preface
This book could not have been written without the generous help and
support of four younger colleagues, much more technically adept than
I: Rishi Goyal of the International Monetary Fund, Kenichi Ohno of the
National Graduate Institute of Policy Studies in Tokyo, Huw Pill of the
Harvard Business School, and Gu¨nther Schnabl of Tu¨bingen Univer-
sity. Each was a co-author and key impetus for one or more chapters,
some of which also have been published as stand-alone articles in pro-
fessional journals. Nevertheless, by splicing with some rewriting all
the co-authored pieces together, and then adding my own individual
chapters with editorial overviews at the beginning and end of the vol-
ume, the result is an integrated book on what I call the East Asian dol-
lar standard.
The introduction shows that there is indeed an exchange rate di-
lemma involving all the countries of East Asia as the scale and pace
of their economic integration has increased dramatically over the past
two decades. Because this increasingly integrated community does not
have its own money—there is no ‘‘Asian euro’’—the U.S. dollar plays
a somewhat anomalous role as the region’s key currency. The peculiar
nature of the foreign exchange risk facing both debtor and creditor
countries under this East Asian dollar standard helps explain why the
region remains so fragile financially.
This book is not about politics, nor is it critical of Asian politicians
and their governments. In Japan, for example, politicians have been
unfairly blamed for failing to take resolute action to clean up bad loans
in the nation’s banks, restructure the industrial system, and avoid
ongoing deflation by following a sufficiently expansionary domestic
monetary policy. Instead, I shall argue that economists—outside
commentators on Japan from the United States but also within Japan