Friday, March 11, 2005
Bretton Woods II? I don't think so...
A recent BIS study provides some convincing evidence that Asian currencies show behavior that is inconsistent with the hypothesis of a “Bretton Woods II”. Asian countries appear to peg not against the dollar, but rather against a trade-weighted basket of currencies. This seems to me like very appropriate behavior, and also suggests that they are not as willing to finance infinite US savings imbalances as is commonly thought. That is, Asian central banks are not going to buy infinite amounts of dollars to keep the US economy afloat.
The above results do not support the conventional wisdom that Asian currencies have gravitated back towards a US dollar bloc since the Asian crisis. Certainly, both the renminbi and the Malaysian ringgit adopted hard links to the dollar during the crisis, prompting some observers to argue that these would drag other regional currencies back towards dollar pegs (Ogawa and Ito (2002)). Academics and others discerned an “East Asian dollar standard” and a “neo-Bretton Woods”.6 However, the significantly positive elasticities estimated above do not lend support to such views, which would predict a negligible systematic relationship between Asian currencies and the yen or the euro.
If Asian currencies are not trading as a dollar bloc, how then should their current trading patterns be characterised? While some observers have envisioned gravitation towards the yen (Kwan (2001), Kim et al (2004)), a more plausible conjecture is that Asian currencies have moved in the direction of an effective exchange rate orientation, somewhat like that of the Singapore dollar (Kawai (2002)). This conjecture is consistent with the observed increase in the volatility of bilateral exchange rates relative to effective exchange rates in 2004 compared to 1996 among the Asian currencies with more flexible exchange rates (Graph 2).7 The Singapore dollar has long seen higher volatility againstthe US dollar than against a basket of its trading partners’ currencies.8 It has more recently been joined by the Thai baht. The Indonesian rupiah and the Korean won show nearly equal bilateral and effective volatilities.