Global Financial Turbulence and Its Implications for East Asian Financial Cooperation

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Global Financial Turbulence and Its Implications
for East Asian Financial Cooperation

• GAO, Haihong
• Institute of World Economics and Politics
• Chinese Academy of Social Sciences
• NEAT Conference, Shanghai, April 12 2008

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Issues to deal with

• Whos in charge?
• Challenges for East Asia
• Regional solutions

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Whos in charge the market?
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1. Massive capital movement cross boarder

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2. High speed of capital transactions

• Active interest arbitrage which is
  sensitive to changes of interest rates and
  exchange rates
• Foreign exchange markets expended with
  daily turnover rising from 200 billion in the
  mid-1980s to about 3.1 trillion in 2007.
  Shortened durations Bonds and notes
  cross-boarder transactions with maturities up to
  one year increased much faster than that a decade
  ago Market turned to be volatileChallenge for
  both global and national regulators

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3. Boom of derivatives
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Whos in charge the dollar?
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The most famous Bernanke speech (2002) ever made
- Like gold, U.S. dollars have value only to
the extent that they are strictly limited in
supply. But the U.S. government has a technology,
called a printing press (or, today, its
electronic equivalent), that allows it to produce
as many U.S. dollars as it wishes at essentially
no cost.
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Global dollar standard

• Lion share in FX reserves

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Global dollar standard

• Key currency for transactions

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Global dollar standard

• An anchor currency
• One extreme Dollarization
• Most popular explicit or implicit pegging
• de facto de jure

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Global dollar standard

• The US s "benign neglect" policy has uneven
  effects for the US and the rest of the world
• Dollar depreciation laid a burden on dollar
  assets holders worldwide
• Dollar depreciation and worldwide pegging
  augmented global excessive liquidity
• Fragility arises from over-reliance on the trust
  in the USs ability of managing the dollar.

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Whos in charge the policy / institutions?
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The policy

• Capital account liberalization is a
  catalyst for financial globalization
• International financial institutions are
  the major pushers
• Developing countries be more exposure and
  fragile to external financial turbulence

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The institutions?

• Ineffective institutional surveillance
• Bigger challenge from the subprime crisis
• IMFs recent reaction

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Implications for East Asia

• Asia is not decoupling from the rest of
  the world
• A divergent development between globalization and
  regionalization
• A wrong signal for understanding the real
  situation of trade and financial relationship in
  Asia
• An export-led growth region with the US as the
  dominant external market
• A less home bias in its international portfolio
  diversification
• Over-reliance on the US dollar

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Implications

• East Asian Dollar standard
• In East Asia, the problem of dollar over-reliance
  is far more difficult to cope with
• Original sin (Eichengreen and Hausmann
  1999)
• Conflicted virtue (Mckinnon and Schnabl
  2004)
• Impossible trinity
• Asia is NOT learning the wrong lessons from its
  1997-98 financial crisis. The origin of the
  problem seems more likely to be the dollar
  standard than its preference of exchange rate
  regimes.

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East Asia has to cope with
uncertain capital flows East
Asia as a creditor
Implications
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Regional solutions

• The whole package of solutions to financial
  instability should be considered from three
  perspectives of global level, regional level and
  individual countries level.
• A solid form of regional financial architecture
  that can provide a shelter for Asia from severe
  global market consists of the following elements
  
• a full-pledged, effective and
  institutionalized regional financial supporting
  mechanism
• Chiang Mai Initiative (CMI) (2000)
  reviewed ( 2004-2005) enhanced (2005, 2007)
• a deep and sophisticated regional
  financial market
• Asian Bond Fund (2003) ABF1 ABF2
• a regional collective exchange rate
  mechanism
• or, to have the Chinese currency
  regionalized/internationalized?