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TitleExchange Rates under the East Asian Dollar Standard: Living with Conflicted Virtue
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Ronald I. McKinnon is William D. Eberle Professor of
International Economics at Stanford University. He is the
author of several books on international economics and
development finance, including The Rules of the Game:
International Money and Exchange Rates (MIT Press,
1996) and, with Kenichi Ohno, Dollar and Yen: Resolving
Economic Conflict between the United States and Japan
(MIT Press, 1997).

economics/finance

“This book is timely and impressive. It synthesizes McKinnon’s work on the nature and
effects of the exchange-rate policies pursued by the East Asian countries. You may not
agree fully with his policy conclusions, but you cannot ignore the arguments and evi-
dence assembled in this volume.”
—Peter B. Kenen, Professor of Economics, Emeritus, Princeton University, and
Council on Foreign Relations

“McKinnon argues persuasively that the ongoing efforts of American analysts and politi-
cians to urge Japan, China, and other Asian countries to appreciate their currencies
against the dollar is fundamentally misguided—indeed, it would unnecessarily damage
those countries and the world economy. Necessary corrective reading for all enthusiasts
of floating exchange rates.”
—Richard N. Cooper, Boas Professor of International Economics, Harvard University

the mit press
Massachusetts Institute of Technology
Cambridge, Massachusetts 02142
http://mitpress.mit.edu

0-262-13451-9

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Exchange Rates
under the

East Asian Dollar Standard
living with conflicted virtue

Ronald I. McKinnon

The increasingly integrated economies of East Asia—
China, Hong Kong, Indonesia, Japan, Korea, Malaysia,
the Philippines, Singapore, Taiwan, and Thailand—face the
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
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
leads to a “conflicted” choice between a possible deflationary
slump if they do appreciate and threatened trade sanctions
if they do not. Analyzing interactions among the East Asian
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
right direction. He suggests that the dollar standard in East
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.

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Exchange Rates
under the

East Asian Dollar Standard

living with conflicted virtue

Ronald I. McKinnon

46956Mckinnon 1/19/05 1:26 PM Page 1

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Exchange Rates under the
East Asian Dollar Standard

Page 146

U.S.
Japan
China

U
S

$
b

ill
io

n
s

In
d
e
x

1
9
8
0

=
1
0
0

1600

1400

1200

1000

800

600

400

200

0
1980 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 012000

Figure 5.3

Nominal Exports, China, Japan, and U.S., 1980–2001. (International Monetary Fund,
International Financial Statistics)

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002

14%

12%

10%

8%

6%

4%

2%

0%

U.S.
Japan
China

Figure 5.4

Exports/World Trade, China, Japan, and U.S., 1980–2002. Smoothed averages computed
by Hodrick-Prescott filter. (International Monetary Fund, International Financial Statistics)

China 133

Page 147

and there is no strong presumption that China will continue to run

trade surpluses multilaterally.

Much more definite is the rapidly increasing bilateral trade surplus

China is now running with the United States. It rose from virtually

nothing in 1985 to more than $90 billion in 2002, exceeding even

Japan’s ongoing (but not increasing) surplus with the United States of

about $70 billion, and rose to well over $100 billion in 2003. Figure 5.6

shows China’s and Japan’s bilateral trade surpluses since 1980 as a pro-

portion of U.S. GDP. Just as striking is the sharp decline in Japan’s

large bilateral surplus with China in the 1980s to a sizable net deficit

by 2001 (figure 5.7).

An alternative way of measuring these dramatic shifts in China’s

geographic trade patterns is to measure bilateral trade as a proportion

of total trade, as shown in table 2.2 in chapter 2. As one might expect

from its huge multilateral current account deficit, the United States has

become China’s most important export market. Although in 1980 only

5.4 percent of Chinese exports went to the United States, in 2001 the

percentage had risen to 20.4 percent, with a strong tendency to rise fur-

ther. At the same time, reflecting economic stagnation, the weight of

Japan as an export market for China and as a source of imports into

5%

4%

3%

2%

1%

0%

–4%

–5%

–3%

–2%

–1%
1981 83 8482 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 2000 01

China
Japan
U.S.

Figure 5.5

Current Accounts as Percentage of GDP, China, Japan, and U.S., 1980–2001. (Interna-
tional Monetary Fund, International Financial Statistics)

134 Chapter 5

Page 291

Stationary expectations, 146–147, 201–205
Stein, Jeremy C., 63
Stock. See Markets
Super 301 sanctions, 97
Svensson, Lars, 53–54, 95
Switzerland, 32, 39, 44, 251n5

Taiwan, 1–2
competition from, 129
conflicted virtue and, 228–231
exchange rate flexibility and, 15
fluctuation rates of, 47, 52
growth rates of, 55
real interest rate and, 188
super-risk premium and, 188
synchronized business cycles and, 54–58
U.S. dollar pegging and, 13
volatility reduction and, 41, 44
Takenaka, 53
Tariffs, 88–89
Taxes, 11–12
Hashimoto and, 80–81, 98
tariffs and, 88–89
Technology, 1
1990s economy and, 79
China and, 138–139
Fisherian model and, 168–170
Japan and, 79, 148
Thai Fund, 220
Thailand, 1–2, 210
ASEAN group and, 58
China and, 143
conflicted virtue and, 228–231
crisis policies and, 32–33, 71
exchange rates of, 15, 181
fluctuation rates of, 47, 52
forced float of, 13
growth rates of, 55
import curtailment and, 21–22
increased flexibility and, 14
interest rates of, 181
Kwan model and, 67, 69
original sin and, 5–6
real interest rate and, 188
stabilization and, 39
super-risk premium and, 179, 188
synchronized business cycles and, 54–58
U.S. dollar pegging and, 13
volatility reduction and, 41, 44–45
Tiger economies, 2
Trade. See Markets
Turkey, 165

Unilateralism, 96–97
United Kingdom, 132, 166, 204, 247
United States
account deficits of, 228–229
automobile industry and, 89
bilateralism and, 129, 134, 136
CAPM model and, 219–220
China and, 129–136, 139, 144
conflicted virtue and, 6–8
Goldilocks economy of, 91
gold standard and, 88
government deficits of, 90–91
Great Depression and, 54, 83, 225
interest rates and, 103
Japan bashing and, 7, 91
Kwan model and, 65–69
liquidity trap and, 149
mercantile pressure by, 77, 88–92
Mundell models and, 209–210
passive approach and, 244–249
sanctions and, 97
super-risk premium and, 179
synchronized business cycles and, 55–
56
tariffs and, 88–89
trade unionists and, 151
volatility reduction and, 39
yen/dollar exchange rates and, 58–76
Urata, Shujiro, 56
U.S. Federal Reserve, 9, 76, 94, 148, 214,
247

U.S. Treasury, 14, 89, 152, 234, 245

Virtual exchange rate stability, 99
Volatility, 253n4
1990s economy and, 78–86
2004 levels of, 13
aggregate demand shocks and, 220–223
cumulative currency risk and, 92–95
dollar weights and, 38–39
domino effect and, 95
ever-higher yen syndrome and, 58–92
(see also Yen)
extraneous rate risk and, 27–28
Fisherian model and, 167–191
fixes and, 197–198
moral hazard and, 28–29
Mundell models and, 209
negative risk premium and, 105–114
original sin and, 5–6, 23–31, 47
postcrisis methods and, 31–45
reduction of, 39–45

278 Index

Page 292

risk and, 11 (see also Risk)
stabilization process and, 38–39, 47–48,
52

super-risk premium and, 178–184
U.S. dollar pegging and, 3
virtual stability and, 99

Wald test, 37
Wall Street Journal, 160–161
Wei, Shang-Jin, 32, 39
Wholesale price index (WPI), 101–102
Williamson, John, 31, 45, 76, 99, 238
World Bank, 1, 22, 55, 143–144
World Trade Organization, 162
World War I, 224
World War II, 246
Wren-Lewis, Simon, 99
Write-offs, 115, 117

Xiang Huaicheng, 143–144

Yen, 3, 5, 14, 239–240, 253n5. See also Japan
1990s domestic market and, 78–86
account surpluses and, 77, 103, 108–109
bilateralism and, 97–98
Bretton Woods system and, 87
China and, 140–143
commercial agreements and, 97
cumulative risk and, 92–95
Dodge Line Program and, 87
dollar standard fluctuations and, 53–76
domino effect and, 95
ever-higher yen syndrome, 58–92
expectations effect and, 95
forward value and, 95
increased worth of, 77, 86–92, 104
liquidity trap and, 78–85, 95–102, 111–
114

monetary accord and, 97–98
money supply expansion and, 53
negative risk premium and, 105–114
overvaluing of, 53
portfolio equilibrium and, 103
trade unionists and, 151
transition policies and, 100–102
unilateralism and, 96–97
U.S. mercantile pressure and, 77, 88–92
virtual exchange rate stability and, 99
zero interest rates and, 84, 87

Yen Bloc (Kwan), 204–205
Yoshikawa, Hiroshi, 105
Yuan, 3, 9, 150. See also China

Zero interest rates, 104, 113, 115, 118, 210
China and, 130
Japan and, 84, 87, 152–153, 239
Zhu Rongji, 147, 162

Index 279

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