Major International Currency Research Articles

De Facto Currency Baskets of China and East Asian Economies: The Rising Weights

We employ a Bayesian method to estimate a time-varying coefficient version of the de facto currency basket model of Frankel and Wei (2007) for the RMB of China, using daily data from February 2005 to July 2011. We estimate jointly the implicit time-varying weights of all 11 currencies in the reference basket announced by the Chinese government. We find the dollar weight has been reduced and is sometimes significantly smaller than one, but there is no evidence of systematic operation of a currency basket with a discernible pattern of significant weights on other currencies. During specific periods, the reduced dollar weight has not been switched to other major international currencies, but instead to some East Asian currencies, which is hard to explain by trade importance to or trade competition with China. We examine currency baskets of these East Asian Economies, which include major international currencies and the RMB in their baskets. We find an evident tendency of Malaysia and Singapore to increase the weights of RMB in their own currency baskets, and a continuously significant positive weight of RMB in the basket of Thailand. These findings suggest that the occasionally positive weights of some East Asian currencies in RMB currency basket reflects the positive RMB weights in these East Asian currency baskets, as these East Asian economies have been systematically placing greater weights on RMB under the new regime of RMB exchange rate.

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Characterizing exchange rate policy in East Asia: A reconsideration

Frankel and Wei [Frankel, J. A., & Wei, S.-J. (1994). Yen bloc or dollar bloc: Exchange rate policies of the East Asian economies. In I. Takatoshi & A. Krueger (Eds.), Macroeconomic linkages. Chicago: University of Chicago Press] developed and popularized a method for uncovering the implicit weights assigned to major international currencies constituting a currency basket. We extend the methodology in two dimensions: include regional competitive pressure and employ a vector autoregressive (VAR) model to overcome simultaneity bias. With these modifications, we confirm the prominent role of the US dollar in the exchange rate policy of East Asian economies beyond the short run. However, despite the high degree of commitment to nominal exchange rate stability prior to the crisis, fluctuations in most East Asian currencies are also significantly influenced by country specific shocks. The findings of the post-crisis period suggest that East Asian exchange rate regimes have become more diverse, with the crisis countries (except Malaysia) exercising even greater flexibility in their exchange rate management. Overall, there is weak evidence that the East Asian economies have been benchmarking their currencies towards regional competitors’ currencies over the longer term.

Overcoming Chinese Monetary Division and External Anchoring in East Asia

There are few recent historical precedents for maintaining the high degree of separation that still prevails between the internal monetary arrangements of Hong Kong and mainland China. This paper explains why this separation is likely to erode and considers the economics of the different forms that monetary unification of China could take. It argues that achieving such unification without resorting to capital controls or expropriation is a precondition for developing a second major international currency in East Asia that would rival the yen. Until the renminbi has been established as an international currency within a unified and sound financial system that has achieved Hong Kong's current standards, there can be no progress toward a regional monetary union in East Asia. An internal goal of Chinese monetary union is banking reform and financial integration, and an external goal is to help emancipate both China and East Asia as a whole safely from the U.S. dollar standard.

Overcoming Chinese Monetary Division and External Anchoring in East Asia

There are few recent historical precedents for maintaining the high degree of separation between internal monetary arrangements that still prevails between Hong Kong and Mainland China. This paper anticipates the erosion of this separation and considers the economics of the different forms which monetary unification of China could take. It argues that achieving such unification without resort to capital controls or expropriation is a precondition for developing a second major international currency in East Asia, rivaling the yen. Until the renminbi has established itself as an international currency inside a unified and sound financial system that is up to Hong Kong's current standards, there can be no progress toward a regional monetary union in East Asia. While an internal goal of Chinese Monetary Union is banking reform and financial integration, an external goal is to help emancipate both China and East Asia as a whole safely from the U.S. dollar standard.

Foreign Exchange Intervention in Developing and Transition Economies: Results of a Survey

Based on evidence obtained from the IMF`s 2001 Survey on Foreign Exchange Market Organization, the author argues that, for several reasons, some central banks in developing and transition economies may be able to conduct foreign exchange intervention more effectively than the central banks of developed countries issuing the major international currencies. First, these central banks do not always fully sterilize their foreign exchange interventions. In addition, they issue regulations and conduct their foreign exchange operations in a way that increases the central bank`s information advantage and the size of their foreign exchange intervention relative to foreign exchange market turnover. Some of the central banks also use moral suasion to support their foreign exchange interventions.

Foreign Exchange Intervention in Developing and Transition Economies: Results of a Survey

Based on evidence obtained from the IMF's 2001 Survey on Foreign Exchange Market Organization, the author argues that, for several reasons, some central banks in developing and transition economies may be able to conduct foreign exchange intervention more effectively than the central banks of developed countries issuing the major international currencies. First, these central banks do not always fully sterilize their foreign exchange interventions. In addition, they issue regulations and conduct their foreign exchange operations in a way that increases the central bank's information advantage and the size of their foreign exchange intervention relative to foreign exchange market turnover. Some of the central banks also use moral suasion to support their foreign exchange interventions.

The future of the dollar–euro exchange rate

Monetary unification in Europe is expected to produce a major new international currency, which may compete with the U.S. dollar as the currency of choice in foreign exchange transactions, financial asset markets and central bank reserves. This study considers two important issues regarding the euro: its global role as medium of exchange, unit of account, and store of value and its position relative to the U.S. dollar. Among the main considerations are differences in cyclical behavior, inflation differentials, trade patterns and capital flows, and risk-return assessments. External diversification of private portfolios and of central banks’ reserve holdings will play a key role in determining the euro’s exchange rate. Overall, despite its rough start, we argue that the euro may emerge as a challenger to the U.S. dollar.

How does EMU affect the Dollar and the Yen as International Reserve and Investment Currencies?

Since EMU represents a currency area with a GDP level and a world market share comparable to the United States, it is widely expected that the euro will become an important international currency. This paper suggests simple methods of how to quantify the effects that EMU may exert on the roles of the dollar and the yen as the other major international currencies. Estimates presented indicate that the euro may indeed lead to a significant decline in the market share of the dollar as an official reserve currency of central banks and as an investment currency of private portfolios. These effects hinge on the assumption that the euro will achieve a reputation similar to that of the deutschmark before EMU. The projected shifts can be expected to materialize only in the medium term so that no immediate abrupt changes in the demand for dollars will occur.

Equity Diversification Internationally

ntil recently, diversification into international stocks has proved valuable to U.S. investors. U.S. investors in internaU tional equities benefited greatly over the past twenty-six years fkom substantial depreciation in the value of the U.S. dollar relative to several major EAFE currencies, including Japan and Germany. As the dollar depreciated, U.S. investors holding stocks denominated in appreciating currencies obtained both the “local market return” of the foreign securities (i.e., the return to local investors in the stock’s host country) and a “currency return” proportionate to the dollar’s decline. Since this trend has been in place for some time, return forecasts used in modeling international securities for asset allocation purposes have necessarily been built on the return distributions that occurred during this period. The effect has been to increase the expected returns of international stocks by the amount of the embedded currency return. In 1995, however, domestic equity markets, proxied by the S&P 500, led international equity markets, proxied by EAFE (the index for stocks in Europe, Australia, and the Far East), by an unusually wide performance margin. Domestic stocks closed 1995 up 37.5% for the twelve-month period, while international stocks posted a more normal 11.2% return for the same period. The decision to diverslfy a domestic portfolio into international stocks substantially reduced portfolio returns relative to an undiversified portfolio during this twelve-month period. Perhaps not coincidentally, in early 1995 the U.S. dollar hit thirty-year lows against major international currencies, before it reversed course and began to appreciate through most of the rest of the calendar year. Although no one can accurately predict the future course of currency exchange rates, it may not be reasonable simply to assume that the dollar’s historic depreciation trend will repeat itself over the next twenty-five years. Rather, it may be more reasonable for institutional fiduciaries to review the impact on their pordolio performance characteristics if the dollar does not continue to depreciate.

The medium-term currency outlook

The article examines the experience of the major international currencies over the period since 1953 and assesses their prospects in the early 1980s. It summarizes the historical background, drawing a distinction between the Bretton Woods arrangement, when the world operated under a notional fixed exchange rate system, and the post 1971 experience which has involved a good deal of ‘dirty floating’ in the absence of any formal system. The paper focuses on the factors which influence exchange rate movements, and examines the practical uses of the analytical tools available, assessing the value, and possible misuse, of exchange rate forecasts in the decision-making process of the Long Range Planner. The author draws certain conclusions about economic policy and the international monetary system and offers some thoughts about the implications of the European Monetary System.