Re: A step forward

["Henry C.K. Liu" <hliu@xxxxxxxxxxxxxx>]

Although the Chinese RMB yuan is pegged to the dollar at 8.2 to 1, its
(and the dollar's) floating exchange value to the yen is of critical
importance to both economies.  In 1998, when the yen fell to 147 against
the dollar, Beijing served notice that a yen below 148 would force the
RMB yuan to devalue against the dollar.  Tokyo and Washiongton took
steps to reversee the fall of the yen.  Washington had put forth the
notion that the Asian financial crisis of 1997 was precipitated by
Chinese devaluation of the RMB yuan from 5 to 8.2 two years earlier.
China has since received praise from Washington for resisting devaluing
the yuan all through the Asian financial crisis that began on July 2,
1997.  Market forces since 1999 have been putting pressure on the yuan
to appreciate aginst other currencies, reflecting China's robust
economy.

In 1996, about $100 billion flowed into East Asia, but in 1997, $150
billion flowed out in three months after July. Even though the
Washington Consensus argued that domestic policies had caused the
crisis, Asian governments have been looking to regional financial
arrangements to protect themselves from similar volatility in the
future. The most visible cause for the crisis was the fixed exchange
rate regimes adopted by Asian governments through the 1990s, all pegged
to the dollar at rates at odds with economic realities.  The fixed
exchange rates had to be defended by the central banks' foreign reserves
earned from trade surpluses.  As speculative attacks gathered force
against Asian currencies, several central banks found themseves drained
of foreign reserves on short order, forcing them to abandon the fixed
exchange rates. As local currencies devalued, it became impossible for
local currency revenue to service short term dollar debts, causing
defaults and bankruptcies and general economic collapse.

To withstand the full fury of money market forces, it has been argued
that domestic policies have to reform in areas such as flexible exchange
rates, corporate governance, capital market deepening and increased
market discipline. The World Bank and the IMF have jointly prepared
Reports on Standards and Codes (ROSCs) to rate countries in eight
dimensions: statistical data dissemination, fiscal discipline,
supervision (of banks, NBFIs, and securities markets), transparency in
monetary and fiscal policies,
payments settlements, corporate governances, accounting and auditing
standards, and insolvency and creditor rights.  Yet, unless an
economically honest, or at least responsive, exchange rate regime is
operative globally, such reforms cannot happen locally. On some of the
eight dimensions, notably corporate governance and accounting and
auditing standards, the US is the leader of questionable practice.  Yet
the dollar was exempt from attacks, speculative or fundamental.

The rapid pace of globalization has brought forth the need for a Global
Central Bank as lender of last resort, regulatory authority, global
rules and standards, etc. But the reality is that this is not likely for
the forseeable future because governments are reluctant to surrender
national soveriegnty in the protection of national economic interest.
What then is the option facing individual governments? Already, the
formation of the EU, NAFTA, MERCOSUR and other regional groupings
demonstrate that other regions are moving ahead with regional
arrangements. East Asia has lagged behind. The many market failures in
the global financial regime markets - panics and herd behavior, are well
documented. Instead of dealing with the real problem, the international
creditor community responds with IMF-type pressure.  Not only will this
approach not solve the financial pressures on emerging market economies,
it is also unfair, bercuase it imposes on these economies austerity
measures they did not deserve, or worse, serves no constructive purpose,
except to perpetuate dollar hegemony. Of course, countries need banking,
accounting, and regulatory standards, but there is no agreed best
universal practice. Even the G-7 cannot agree among themselves on a
common standard. Even after Enron and telecom IRU swaps controversies,
the US continues to resist regulation in favor of market discipline. Yet
under pressure from the IMF, developing countries are being forced to do
what the US rejects for itself . In reaction, East Asian countries have
gotten together to discuss this issue and to arrive at their own common
standards. East Asia is quite capable of becoming a common currency
area.

The most important changes to the world's financial architecture are
likely to come from the new regional
arrangements being realized in East Asia by Japan, China, South Korea,
and the ten member countries of
ASEAN. The idea of a multilateral cooperation agreement was revived on
May 6, 2000, when the finance ministers of the ASEAN+3 countries met in
Chiang Mai, Thailand, and concluded an agreement called the "Chiang Mai
Initiative" (CMI).

The CMI was the first and significant step in official financial
cooperation for the whole region, better enabling the region to cope
with potentially disruptive currency fluctuations and international
capital movements, so that the countries within the region can protect
themselves from volatile and unpredictable capital movements. As a
follow up on the CMI, an ASEAN Central Banks Forum took place recently
in Brunei and Kuala Lumpur. The 10 monetary authorities of ASEAN then
agreed to expand the size of
the multilateral currency swap facility among the member countries from
US$ 200 million to US$ 1 trillion. It should be reported that the
uniform framework of bilateral swap agreements between the 3 North East
Asian countries and ASEAN was debated by the 10 + 3 leaders in their
Singapore Meeting in November 2000 and Kuala Lumpur Meeting in April
2001. And in Honolulu, exactly one year after the CMI was announced,
three bilateral currency swaps agreements between South Korea and Japan,
Malaysia and Japan and Thailand and Japan amounting to additional $6
billion have already been signed.

The Chiang Mai initiative, which is a bilateral swap arrangement among
13 countries -- achieved much more than expected. With monitoring and
surveillance, it can be the beginning of an Asian Monetary Fund. The
arrangement has already been in existence for a year and particpating
countries are working together on the regulatory arrangements.

The proposal of an Asian Monetary Fund initially received a cool
response from the IMF and G-7, led by Washington, but their position has
softened since. IMF Managing Director Kohler said that an Asian Monetary
Fund would be acceptable if it were complementary to the IMF, and this
has been echoed by the G-7 and ASEM. Monetary cooperation in East Asia
has progressed at an encouraging pace. Examples of such cooperation
include the work toward the Asian Monetary Fund, Manila Framework Group,
ASEAN surveillance process, ASEAN+3 surveillance process, Chiang Mai
initiative, bilateral arrangements, short-term capital flows monitoring
by the ASEAN secretariat, ASEAN+3 early warning system, Third ASEM
finance ministers meeting, and the Kobe Research Project.

Structural reforms while necessary is not enough.  There is a need for a
safety net through a regional financial arrangement. Asia needs an Asian
system, operated by Asia and for Asia.

Exchange rate stability and monetary coordination are legitimate
regional multilateral concerns. Capital markets nowadays are global but
market power is not equally distributed. A regional financial
arrangement to deal with its implications then becomes necessary. US and
European standards are converging rapidly. The Basle Capital Accord is
becoming more inclusive and East Asian countries are participating. Yet
there is evidence that the Japanese banks' problems are caused largely
by the "international" standards of capital requirments that do not fit
Japanese historical conditions well. While it may make sense to pool
risks at the global level, it makes even more sense to pool them at the
regional level because international standards may not be sensitive to
regional conditions.

Sakakibara Eisuke, former Japanese vice finance minister for
international affairs, is an inititaor of an Asian monetary scheme. It
has a distinct Japanese provenance - even though Finance Minister
Miyazawa Kiichi denies any link between the current plan and one bearing
his name that emanated from Tokyo in 1997. Washington vetoed that
proposal during an IMF meeting in Hong kong, which called on the Asian
Development Bank to support Asian currencies that came under speculative
attack with a special $100 billion fund.

The signatory goverments of CMI agreed to contribute $40 million each to
a common fund. The money will be used to allow them to swap each other's
currencies and run a system to spot threatening moves in currency
markets. Still to be resolved are the details of the "swap" mechanism,
and exchange rates. The plan is to build up a $20-billion war chest (an
amount proposed by Sakakibara). The AMF won't replace the IMF, but it
could be a quick-reaction force to avert disaster while the IMF
deliberates on global implications.

Bilateral relationship between an emerging East Asian economy and the
lead global economic power was historically the strategy for a regional
economy to achieve growth. This phenomenon, which brought economic
growth in tandem with interregional relationship that lacked sufficient
diversification, rendered the economies of the region susceptible to
severe and excessive external shocks. Most major East Asian economies
depended on extra-regional trade and investment, while intra-regional
financial flows were relatively light. Sudden and simultaneous capital
flights by extra-regional investors and creditors left the region
devastated in 1997. The concentration of foreign currency-denominated
external loans was an economic disaster to the countries in the region,
because practically all of them were short of foreign exchange for
external debt repayment when the financial crisis erupted in 1997. When
local currency depreciation precipitated a loss of confidence on the
part of foreign investors and creditors, short-term external loans were
recalled and massive capital flights followed. Many Asian countries were
caught short of foreign currency assets, and external debt repayment
difficulty mounted overnight.

Currency speculation that contributed to the triggering of a process
that led to the economic collapses of several countries in Asia was a
clear proof of the lack of effective, cohesive cooperation in the
region. The only option remaining at the time was to turn for assistance
to stronger economies and international financial institutions whose
interest were not closely aligned with those of the region. In order to
prevent international currency speculation, it is essential that any
preventive financing be arranged in large amounts and very quickly. Hong
Kong with its huge dollar reserves, was able to withstand speculative
attacks, albeit at high cost. What is even more important therefore is
the sheer availability of a sufficiently large financing facility
standing ready to assist. Such readily available financing can serve as
an effective, preventive mechanism against the possibility of a balance
of payments difficulty. International organizations, that endeavor to
provide assistance financing globally are already spreading their
resources too thin. China and Hong Kong each provided the IMF with $1
billion in July 1997, with the understanding that the IMF would contain
the crisis within Thailand. Instead, the IMF exploited the crisis to
promote dollar based global market fundamentalism.  The East Asian
region therefore must accept the fact that it has to rely on itself more
than on outside help alone.

Unlike many of the cases in Latin America, it can be argued that the
balance of payments problems of
1997-1998 in Asia were not fundamental but transitory in nature. They
were in fact due to unforeseen and sudden capital outflows. Moreover,
the crisis could have been a mere temporary setback had it not been
further aggravated by restrictive IMF policy stances taken in the
earlier days after the crisis. The Malaysian temporary financial
derailing, may provide a case in point and swift deinternationalization
of its currency worked. For the most part, the Asian financial crisis
was thus more of the capital account-related nature than that of the
traditional current account disequilibrium.

Following the 1997 economic crisis, Asian countries began to look inward
within the region. The concept of self-reliance and mutual support,
lying dormant for so long under the domination of globalization, has
been revived. Although regional trade cooperation in Asia has been
continuously strengthened via economic consolidation, cooperation in
financial areas still leaves much to be desired. Financial illiquidity
of Asian countries during and immediately following the crisis provides
sufficient evidence to prove the point. Hong Kong suffered for its
market liquidity rather than fundamental weakness.  Regional investor
sold in Hong Kong to try to save their investments in other illiquid
parts of the region.  The 1997 financial crisis of Asia necessitated
international financial adjustments in the crisis-hit countries. Japan,
China, Hong Kong and other Asian countries were ready to help, despite
their own domestic problems, but was prevented from doing so by
Washington.  This brought about the awareness of need for greatly
enhanced intra-regional trade and finance and led ultimately to some
form of coordinated, intraregional, financial policy framework and
shared financial resources, something close to a new international
financial architecture for Asia.

In order to strengthen self-help and support mechanisms in East Asia
through the ASEAN+3
framework, the need to establish a Regional Financing Arrangement (RFA)
to complement the existing
international facilities is recognized. The CMI multilateral and
bilateral swap facilities that are put in place among the 10 + 3
monetary authorities will be utilized only when one or some countries
encounter short-term and temporary balance of payments difficulties.  In
the framework of the RFA, the emphasis is placed on the role of the
regional currencies. This is a major theme in the arrangement. The lack
of
currency diversification in the past led to detrimental effects
associated with external payments difficulties. The multi-currency
placement mechanism is thus designed in an attempt to reflect this
diversification objective. Based on the amount of total out-placements,
each country can then borrow up to a multiple of the placement amount, a
concept similar to the much practiced margin loans in the securities
business. A formula to determine each country's multiple would be
developed and negotiated, perhaps on the need to borrow and ability to
repay basis. Once the multiples are agreed upon, each of the monetary
authorities can utilize the multilateral and bilateral swap facilities
up to the maximum amount as determined by the respective multiples. The
RFA also introduces a new element in regional financial cooperation, one
of building up a formal and committed relationship among the
participating member countries from day one onwards, prior to any
borrowing actually taking place. The system so envisaged will in effect
become a mutual give and take, which forms a fair and logical foundation
for financial self-help and support
among monetary authorities of the East Asian countries.

The countries within the region need to be protected against serious
balance of payments and international
liquidity problems. The financing facility required for the purpose must
be accompanied by proper monitoring of capital flows and an efficient
regional surveillance process. The resulting regional financing
arrangement (RFA) will then constitute an important element in East
Asia's self-help and support mechanisms. The development and
implementation of the RFA must therefore be expedited with binding
commitment by the regional member countries.

The implementation of the ASEAN Swap Arrangement (ASA) and some one-way
bilateral swaps
agreements between Japan and the three countries have been finalized
thereby completing the first building block of the East Asian financial
cooperation. By the end of the year 2001, comprehensive research have
been done on the subject of capital movement monitoring within the
framework of ASEAN+3. By June 2002, Two-Way Bilateral Swap Arrangements
(TBSA), or arrangements whereby China, Japan, and South Korea can
financially assist one another in a reciprocal manner in times of
similar needs, should also have been instituted. The second building
block in the framework of ASEAN+3 financial cooperation will have then
been completed.

Then the third building block of mutual placements will be completed
among the 13 regional countries as
the foundation of the RFA scheme by year-end 2002 at the latest, by
which time obstacles to the regional
financing arrangement will also have been eliminated or minimized. In
order to get the new RFA scheme off the ground rapidly, concrete
operations can conceivably begin to proceed step by step as early as
possible. Each of the ASEAN+3 countries that is willing and
well-prepared enough might begin by making some bilateral agreements
within the framework of this scheme and then keep on expanding the
number of new partners with which further agreements can be made. Once
all the possible pairings of countries are achieved, full-scale
"constructive engagement" of the multilateral RFA scheme will thereby
have been completed and a full-fledge preventive scheme created and
ready to be activated whenever called for by the events. The monitoring
and surveillance unit for the ASEAN+3 countries will have built up its
expertise and facilities such that it will stand ready, together with a
final decision making body well institutionalized to deliberate on
recommendations tabled by the monitoring and surveillance unit upon
regional member countries' requests for drawdowns of assistance funds,
by mid-2003. Within a decade pursuant to the time when the
multi-currency placements will have been made, regional financial
cooperation and institutionalization will have grown to a point where a
common currency area will become a viable and realistic option for East
Asia.

In the near future, the Finance Ministers and Central Bank Governors of
the 10+3 East Asian countries will have the final say as to what would
be the modalities, sizes, mechanisms, operating procedures,
rules, and regulations of East Asia's RFA. Whatever and whenever they
finally decide upon as a logical follow-up to the CMI, East Asia will
move another step closer to the ultimate goal of intraregional
cooperation and integration to stabilize the foreign exchange markets
and macro financial systems of the member countries.

This newly proposed RFA scheme would aim at eventually becoming
complementary to existing international facilities in terms of the
out-placements made upfront as well as the timeframe involved in the
operations; it would have sufficient size; and it would allow certain
ASEAN member countries to benefit from the financing from the North East
Asian countries, which they otherwise might not be able to gain access
to under a bilateral framework. There is also the question of moral
hazard, whereby a country realizing that there is emergency rescue
funding available might become less cautious with its macroeconomic
policy management, particularly as related to the balance of payments. A
crisis to be avoided would therefore be inadvertently made to happen. To
avert the problem of moral hazard,
the scheme as proposed must be accompanied by an effective and efficient
system of surveillance, self-
monitoring, peer review, and final decision making capability.

China views the Chiang Mai Initiative as a substantial step toward
financial cooperation among East Asian countries. The objective is to
complement existing current international facilities ---- by providing
liquidity
support for the nations in the difficulty of international payment.
According to article 7 of the CMI, 10+3 finance ministers also mandated
ASEAN secretariat, on top of currency swap agreement, to work on
appropriate self-financing vehicle for the region with a view to
strengthening the collective capacity against possible future financial
crisis.

East Asia Cooperation has a strong political commitment, thereby
creating a solid foundation and impetus for further development.  In the
face of the difficulties posed by 1997 Financial Crisis, the leaders of
Asian Countries have realized that it is imperative for them ----
through coordination and cooperation---- to strengthen collective
capability against crises so as to recover their economies as quickly as
possible. In this context, the leaders of ASEAN, China, Japan and Korea
took advantage of the 30th anniversary of
ASEAN to hold their first informal meeting in Malaysia in late 1997.
Since then, leaders of ASEAN+3 met regularly and had in-depth
discussions on the issues concerning regional finance, economy, politics
and security etc. Specifically, they reached the consensus on the key
role of financial stability in sustaining
regional economic development. The leaders also shared the conviction
that to build a peaceful environment for economic development serves the
greatest common interest of East Asian countries. To this end, it is
imperative for the East Asian countries to strengthen coordination and
cooperation among
themselves. In November 1999, leaders of 10+3 issued the Joint Statement
of East Asia Cooperation in Manila, which crystallized the direction and
priority for the future by highlighting the importance of developing
economy through cooperation.

In light of this principle, the concept of regional financing mechanism
symbolized by the CMI has been moving forward steadily while the
cooperation in trade and investment is making headway.

The financial and economic cooperation under 10+3 framework has given a
spur to  the progress in overall East Asian Cooperation. In November
2000, the fourth 10+3 informal leaders meeting in Singapore agreed to
designate two task forces to study the possibility of transforming
informal meeting to summit and establishing an ASEAN+ Northeast Asia
Free Trade Zone. Moreover, the leaders of China, Korea and Japan agreed
to meet regularly on the occasion of 10+3 leaders meeting since 2001.

Given diversified background in history, culture and level of economic
development, the East Asian countries must pursue regional cooperation
in a gradual and orderly manner, taking into account their unique
characteristics.   Compared with other regional cooperative mechanisms,
particularly the
European economic and monetary union, Asian nations are more diversified
in history, culture, political regime, and levels of economic
development. In recent centuries, Western imoperialism and colonialism
have fragmented Asia.  the cold War further extended that
fragmentation.  Therefore, there is still a long way to go and arduous
task ahead for these nations. And they must choose a cooperative pattern
suitable to the regional  characteristics rather than blindly copying
the model of others.

It is noteworthy that the evolution of ASEAN itself experienced several
stages. It started with those countries of similar economic features,
then was gradually expanded to more countries. Likewise, the current
cooperation among the East Asian countries should also start from the
areas where the consensus can be more easily reached, and then spread
gradually on the basis of consolidation.  Contrast to other regional
organizations that started from trade cooperation before their
expansion, the East Asian Cooperation started from the financial field
where they shared consensus before the comprehensive cooperative
relations could be gradually established in the field of finance, trade
and investment.

The East Asian cooperation has emerged along with the vigorous momentum
of regionalization in global economy, which is consistent with economic
globalization. Globalization has two sides to the coin.
While having accelerated world economic development, it has also brought
about the problem of uneven distribution of benefits, thereby
accentuating global economic polarization. As a result of dramatic
advancement of modern information technology, the Digital Divide has
further widened the income and
development gap between the developed and developing countries. Many
developing countries found themselves increasingly marginalized in the
course of globalization.

Developments in Asia do not always received asequate attention in the
Western media.  This summary may serve to help correct the impression
that Asia is merely an appendix of a Western global system.

Henry C.K. Liu

Kazuhiro Kurose wrote:

> > Chinese Central bank chief Dai Xianglong yesterday said he
> would
> > "seriously consider" an International Monetary Fund
> proposal to ditch
> > the yuan link to the United States dollar in favour of a
> link to a
> > basket of currencies.
> >
> > Full convertibility and free float next.
>
> In FT's web site on March 28, I found the article that China
> and Japan signed a yen-yuan swap agreement. What kind of
> attitude China takes toward US as well as Asia is the very
> critical to the world political economy in both political
> and economic sense. China signed the agreement, as said in
> the article, even though her capital account is not
> convertible, which means that the yuan is not vulnerable to
> speculative currency attacks. What is the implication on
> these facts??
>
>  **************************************
>   Kazuhiro Kurose
>   Graduate School of Economics and Business
>   Administration, Hokkaido University
>   Kita 9 Nishi 7, Kita-Ku, Sapporo, Japan
>   060-0809
>     TEL: +81-11-716-2111 ex:2786
>  **************************************