Brad Setser

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An Asian OPEC?

by Brad Setser
February 24, 2005

A less kind headline might be “Asian policy makers meet, agree to continue manipulating foreign exchange markets”

Still, this Bloomberg article (link thanks to Calculated Risk) suggests that there may be a bit of back story behind the statements that Japan, Korea and Taiwan put out indicating that they each had no intention of diversifying the currency composition of their reserves.

Asian officials agreed on Feb. 22 to set up an organization called the Asian Bellagio Group to stabilize regional foreign-exchange markets, the Korea Times reported … “What happened with Korea was not desirable and not what they wanted,” said Stephen Jen, global head of currency research at Morgan Stanley in London. “The interests of the group is that they should do nothing to undermine the value of the dollar.”

Barry Eichengreen of Berkeley has argued that Bretton Woods 1 — the system of fixed exchange rates set up after the World War 2 — only lasted as long as it did because it was backed by a set of institutions that made it easier for the world’s central banks to cooperate to support the system. The key players at the time were mostly in Europe, so most of the institutions had an “Atlantic” tilt. These institutions were more than just talking shops: there was a core commitment by the central banks not to convert their dollars into gold (and to jointly intervene in the gold market). Remember, in the initial Bretton Woods system, the dollar was pegged to gold, and everyone else pegged to the dollar. This kept Bretton Woods 1 going long after it was clear that the US lacked the gold needed to back all the dollars that the world’s central banks were holding.

Eichengreen observed that similar institutions to facilitate cooperation were lacking, and concluded that Asia would not be able to agree on who should bear the burden of supporting the dollar. The temptation to diversify (or at least try to diversity) before the other guy would be too strong.

Of course, there is an alternative thesis: new institutions will be created to help generate the needed cooperation.

Count me a skeptic. I want to see the “Asian Bellagio” countries do more than just coordinate the announcement that the big players have no intent to diversify.

Sure, all the big Asian economies would rather not see their currencies appreciate against the dollar, particularly if China remains wedded to its peg. But each Asian economy would presumably also prefer to see someone else add to its dollar reserves and take the (future) losses associated with providing the US with the financing the US needs for the system to keep on going.

Stephen Jen’s take on all this continues to amuse me. Jen, Morgan Stanley’s chief currency strategist, believes that the dollar is fundamentally undervalued, despite the growing US trade deficit. Tis true that most countries in the world would rather not see their currencies appreciate against the dollar.

“It’s in nobody’s interest for the dollar to fall,” said Jen. “The Europeans are clear they don’t want to see the dollar fall further, so are the Japanese, and now the other Asian countries are saying it.”

But if nobody’s currency appreciates against the dollar, the United States’ need for external financing is likely to keep on going up along with the expanding US trade deficit. The real question continues to be “who is willing to finance the US in order to keep their currency from appreciating?” So far this year, the only central banks that has building up its dollar reserves at a rapid pace seems to be Bank Negara Malaysia and the People’s Bank of China, though China has not confirmed this with the release of their January reserve data.

I suspect some other central banks may need to enter the market to keep the dollar from depreciating and, in the process, provide the US with the financing it needs to US run large current account deficits. Just a hunch.

I don’t think the system of Asian reserve financing is stable, but I also don’t think it will come to a clean, sudden end either. There will be lots of fumbling around before interests are clarified and the really hard decisions are taken …


  • Posted by CalculatedRisk

    Roubini gets a nice mention on Page 1 of the WaPo today:
    Foreign Investment’s Flip Side
    U.S. Trade Deficit Swells Along With Consumption, Debt

  • Posted by CalculatedRisk

    Just curious – Do you think Keynes’ proposal of an International Clearing Union at Bretton Woods would have prevented the current situation?

    If I remember correctly, Keynes proposed that the ICU would create the World’s reserve currency and countries that ran excessive current account surpluses or deficits would have to pay penalties to the ICU. Theoretically (it seems to me) that would have prevented the current situation.

  • Posted by Jesse

    There are some really remarkable things going on in the world of money. The US Treasury is now breaking its own rules, and issuing overnight and multiple per day repos, in an exact imitation of the Fed’s own open market operations, and are doing it in size.

    One can truly ask who is setting the monetary policy of the United States these days, and how they are doing it.

  • Posted by DF

    I’d like to add : how long will it go on ? And is a happy ending possible ?

    From what I see this the game being played is something like this :
    If world economy was a plane, the debt / GDP ratio is a huge montain barring future growth.
    THe plane is flying too low, and the only way to move forward would be to take altitude, which would imply to circle sometime upward.
    The problem is that the pilots in charge do not want that, they are hooked on speed. So instead of circling up, they’ve decided to dive in front of the mountain. Faster and faster.
    And we are seing the ground approaching at an ever growing speed.

    I mean what are those people thinking ?
    What is the way out ?
    It looks like a collision course to me.
    Another representation would be a herd of sheep running toward the cliff. Noone can stop without being stumped over, so let’s run faster.

    But again, who is rational in this ? WHAT ARE THEY THINKING ?

    That the deficits will disappear ? That wages will rise ? That free lunches will fall from the sky ?

  • Posted by anne

    Stephen Jen

    “It’s in nobody’s interest for the dollar to fall,” said Jen. “The Europeans are clear they don’t want to see the dollar fall further, so are the Japanese, and now the other Asian countries are saying it.”

    Brad Setser

    But if nobody’s currency appreciates against the dollar, the United States’ need for external financing is likely to keep on going up along with the expanding US trade deficit. The real question continues to be “who is willing to finance the US in order to keep their currency from appreciating?”

    The question perfectly posed.

  • Posted by steve kyle


    I suspect what the politicians are thinking is that maybe the disaster wont happen today and maybe something will happen to make this problem go away before I have to do something unpleasant. At a minimum the politicians will need a bona fide in-your-face crisis so that they can claim it wasnt their idea to do the necessary unpleasant thing, but that it was forced on them by a cruel world.

    Politicians dont have the same objective function as the countries they run. Nor do they have the convictions about where we are headed that most economists do – In fact, there are still a fair number of economists out there who think all will adjust smoothly and happily – The politicians would rather listen to them.

  • Posted by PaulO

    Hopefully not a stupid question (apologies if so):

    Do you think they’re willing to support the dollar is because they perceive:

    1) A dollar fall would hurt their economies presently.
    2) As long as the US is sending them dollars and bankrupting itself, such bankruptcy doesn’t really matter to them, and they can’t do anything about it anyway.
    3) They simply don’t have domestic demand in place yet and are trying to build it now on the backs of US debt.
    4) They haven’t thought through the ramifications of the US endgame, which must be among:
    a) inflate (in which case their reserves lose real value, but relative to the US they’re still in better shape, having dollars and claims versus the US having only net debt)
    b) default (in which case, from a relative standpoint they’re still better off than the US, as holders of reserves vs. US debt).
    c) improvement in the US behavior (seems next to impossible, given entrenched habits and shortsightedness)?

    Since they have no control over the US’s desire to indebt itself into oblivion, are they simply trying to be sound and “saving up for the rainy day” everyone expects to come, to achieve a better situation relative to a weakened US at the end of the adjustment?

    In other words, are they making the calculus between clear pain now and some kind of more distant pain in the future, but one with the US in a far weaker relative position in the world economy, something ultimately desirable to them and worth the price?

  • Posted by jm

    It’s vendor financing, like in the telecom bubble, but there’s no SEC or FASB or other external agency to make them come clean on the accounting. Ahhh, we live in interesting times.

  • Posted by DF

    I can’t see how any economist with a brain can think it will adjust smoothly and happily.

    And I ve never read anything about how it will adjust anyway …

    So far all I hear is silence, which is the equivalent as saying : debt can rise forever.

    But this is false. The USA can not borrow always more to the rest of the world.
    The consumer can not borrow always more to the banks.
    Debt have to be repaid sometime.
    The debt/revenue ratio has to be stabilized sometime and then fall.

    I’m still waiting for someone to show me how we can have both falling debt/revenue ratio and rising revenues (GDP).

    I think in a democracy we have the politicians we elect. There’s no blaming them. (Whereas there’s a lot to blame on the economists, they’re supposed to know better).

    I think it’s ok to ask for some coercition from the rest of the world. I mean if there was no risk at all of sanction, lots of people would not get up to go at work. But come on … There are limits to this. You can’t just shoot in your own foot and blame others from not preventing you from doing it.
    This financing is organised economical suicide of the future world economy. This is increasing the prozac pills to the point that there s a health risk.
    Some people will have to account for this, and I say people will get REALLY angry.

  • Posted by Df

    In response to paul O. Yes may be the asians feel that they will fare better than the USA in this ultimately lose-lose game. They will lose less.
    Besides the USA did much the same in the 20’s when they helped the britons in keeping an overvalued sterling. This lead to the speculation we’ve heard off and the consequences we’ve heard off.

    But it’s wrong to imply that “they have no control over the US’s desire to indebt itself into oblivion”.
    The US desire would meet the dire reality if interest rates would rise. The USA could be forced to save.
    The asians have a huge responsability in all this, they’ve played the card of undervalued currencies from the start.
    From where I stand, the crash ahead will call for more than just a return to “sound policies” of balanced budget. The problem is the role of credit in the creation of money.
    The link below does not look very academic, and lots need to be added. But they are asking a very important and wise question.

    As long as debt/GDP ratios are left without control, there will be huge crisis around, as booms (excessive lending) leads to crashes (credit crunch deflation).

  • Posted by glory

    bill gross’ attempt to explain the “conundrum” 😀


  • Posted by brad

    Like Gross’s graphs.

    This is an important point:

    “After all, if foreign central banks and others continue to absorb 70%+ of the bond market’s new supply (900 billion out of an estimated 1.3 trillion in 2004), why wouldn’t this “squeezing” out of domestic investors continue unabated, with yields continuing to move lower?”

    Obviously, it depends on the sustainability of the $900 b net inflow into US fixed income from abroad.

  • Posted by IJ

    Whether an Asian Monetary Fund will do any better than the IMF is doubtful. In a speech on Wednesday, the MD of the IMF talked of the chaos of global imbalances and said:

    “As the main institution tasked with facilitating international monetary cooperation, the IMF provides the forum-and the tools-for our global membership to tackle the problems at hand, and to encourage appropriate action by countries.” The IMF has apparently done all it can – if key nations choose not to use the global mechanisms set up, or indeed any mechanism, to sort out the global economy there’s little the IMF can do.

    Perhaps this was behind last week’s recommendations from the IMF to the European Union for “the establishment of independent national fiscal councils in each country to report to national parliaments on budgets and stability programmes.”

  • Posted by steve kyle

    an Asian institution cannot possibly solve the current problems – they arise in the US not in Asia. all an asian institution can do is spread the pain equally around asia and solve the problem of one Asian central bank trying to leave the others holding the bag. But the bag itself is being filled from outside – and there isnt much they can do about that.

  • Posted by PaulO

    Steve –

    My point exactly.

  • Posted by anne

    Nicely put, Steve.

  • Posted by gillies

    most comments are still being made from cold war perspectives. are not china and the u s deeply intertwined in trade, investment, outsourcing of jobs and holding of investments? are their economic interests not at least linked, if not handcuffed, together?

    and most comments are made as if peering into a fog to try and discern the future. but the longer term future is already known. china with five times the u s population cannot complete its rush for growth – for at levels of only 20 per cent of u s per capita consumption, in any commodity, china becomes the world’s largest consumer. and as for catching up u s standards of consumption, there are not enough resources in the entire world to support that – except perhaps coal, the use of which will need to be progressively reduced to prevent global warming.

    so it is not going to happen.

    so there is no happy ending for expanding economies.

    so the only remaining aims are the short term ones – win a second term – complete chairmanship of the fed without major upset – maintain oil company profits for another twelve months – etc.

    i think that the medium term future lies outside of the narrow range of possibilities that can be calculated or extrapolated from the figures relating to the present and recent historical past.

    greenspan may be doing no more than whatever it takes to keep the plane in the air.

  • Posted by jm

    All we need to do is learn from the Japanese.
    They’ve alrready shown us exactly what needs to be done: Have the US Congress budget an amount prooportional to GDP, say, $2 trillion*, for purchase of yen and yuan on the open market. Then start buying with it. If it works for the Japanese, it should work for us, too, shouldn’t it?

    *Because our GDP is twice Japan’s, and they budgeted $1 trillion.

  • Posted by brad

    jm — One potential problem: the yuan/ renminbi cannot be bought on the open market. China maintains capital controls for a reason.

  • Posted by gillies

    are there any free market capitalists left on earth ?

    the more we puzzle over the adsurdities of competing fiat currencies – the more i see the central bankers of america, europe, and asia as a bunch of communists, dedicated to centralised control of the economic levers, behind a mere facade of a free market.

    mr greenspan as a crypto communist. there’s a new one for you.

    mr greenspan as a crypto communist. there’s a new one for you.

  • Posted by Movie Guy

    I spent much of this past week around very hardcore Republican types. One theme came through over and over. The twin deficits are not a problem. The U.S. will grow its way out of its troubles. No sweat.

    The Asians will always buy our treasuries, or we will put massive tariffs on their goods, etc.

    I inquired with many over their sources of information. Each of these professionals identified one common source among others: Fox News

    All is well.

    And, yes, we’re going to nuke North Korea, China, and anyone else in our way.

    Think about it. Friends of these people run the country…

  • Posted by Stormy

    There are many ways to rein in an irresponsible imperial power; I suggest the way being pursued is economic. China is noted for its “patience” and the “long game.” The rest, almost without exception—Korea, EU, Middle East, you name them—are concerned about the unrestrained, unprincipled projection of power. How else to weaken such a power but by sapping its economic might. Yes, such sapping will be expensive—the economic cost to be born when the dollar is devalued–, but armies are perhaps more expensive, especially when the power in question has a significant head start. In the meantime, build your own infrastructure and internal markets; start to diversify those markets internationally. I am not saying that the non-U.S. world has hit upon this idea collectively. But individually they all must be thinking it. There are many ways to handle a tiger in your village.

    Along these lines it would be interesting to note how many non-U.S. markets are being developed and groomed. As someone noted in a past blog, there are many regional trade agreements being developed that do not include the U.S. The U.S., meanwhile, prefers to do one-on-one agreements, in an attempt to leverage its power. In creating these non-U.S. regional agreements, the world is simply responding naturally to the U.S. And it makes sense that they need to weaken the U.S. to the point where they force it to act responsibly and to enter willingly into international agreements, not arrogantly decide how it will proceed independently of any such agreements.

    Games, games…think of the strategy needed if all this were simply a board game. If I were a leader of a foreign country, I would certainly be thinking ahead, considering how to best serve my country’s long-term interest and safety. If armies are out of the question, then economics would certainly be an alternative.

  • Posted by IJ

    Some support in the blogosphere for ‘Stormy’. This interesting post agrees that politics will eventually lose out to global economics. Local governing arrangements will take second place to human nature.

    For example, it looks as though Europe will end its indefinite arms embargo on mainland China. Because it wants to build relations that lead to more mutually beneficial trade with that huge country. It would be following in the footsteps of Israel and Russia.

  • Posted by gillies

    there is a natural balance in geopolitical alliances. if a sole superpower is as strong as / spends as much on their defence budget as, the next 25 countries – then defensive alliances of two or three or a dozen small nations are ruled out of contention. there is nowhere left to go except either submission to a global neo colonial system, or a grand alliance of eurasian countries – from france and germany through russia to china and korea.

    there is no need for a conspiracy to promote economic resistance to superpower expansion – resistance through military means is ruled out, for all except the suicidal, so what is left ? thus there may be no conspiracy – but if there is a shared perception among eurasian nations, it is surely the superpower who has created that perception ? and the neo cons in particular.

    even hardcore republicans will not nuke shanghai, not if they check first how much u s money is riding on the shanghai property boom.

    modern economies are a complex web of relationships – many of them merely electronic. you can loot grain, gold, slave girls, obelisks, paintings, horses – but the trade in a futures market, or the affections of a people, are things which can disappear beyond recovery when force is attempted.

  • Posted by brad


    your earlier comment:

    “are not china and the u s deeply intertwined in trade, investment, outsourcing of jobs and holding of investments? are their economic interests not at least linked, if not handcuffed, together?”

    reminded my that those who bought internet IPOs (and held them), those who sold internet IPOs (investment banks) and those who ran .coms (and worked for them) were also economically handcuffed together for a time, or if not handcuffed together, at least linked together economically. They enjoyed each other’s company a lot more on the way up to NASDAQ 5000 than on the way down …

    The Barnett “connectivity” argument will be tested, I fear, when both the US and China have to adapt to the eventual reality that the overall US trade deficit has to dead down rather than keep on rising. The economists favorite word, “adjustment,” is a bit too bland to describe fully all the actual changes that would follow. The renminbi falls, leading to financial losses in China’s central bank and real losses in China’s export industries. The US economy slows/ perhaps US financial asset prices fall too (on the back of higher interest rates due to less foreign capital). The US budget deficit starts crowding out domestic investment, and there is real pressure to reduce it — which means choosing between guns, butter and tax cuts rather than saying I want more of all three. I think all these changes are in broad terms necessary to put the US/ world economy on a more solid foundation, but I don’t think they will be easy.

  • Posted by p

    This is a great blog with many great posts. The one thing I keep getting stuck on is if a theory cannot explain a significant phenomena, then it is NOT a useful theory. Current economic theories cannot explain the conundrum that we are in. This results in a political argument where some wish to blame Bush or Republicans and others seek to blame liberal thinking. One thing is clear to me, both are wrong and not advancing our thinking on how to resolve the problem or even understand it.

    The real question to me is what theoretical lens can be developed to provide us with both a means of understanding how we reached this point and what are the levers we can pull to begin moving out of this problem.

    I think that standard economic models fail to frame the problem for a sveral reasons:
    1.we are not on the margin
    2.equilibrium is not clearly definable
    3.the global economy is more open than closed
    4.the nation state as the accounting aggregator is error prone (who really holds assets and debt)

    I think the third point is the most important one to focus on because it helps explain why the first two are issues. I think that the institutions that define the markets are clearly in flux with the rise of China and Asia. Specifically, the various institutions that shape the market are playing on different time horizons and towards different ends. In the old Bretton Woods world Europe and the US played the major roles. They had roughly similar goals and time horizons. This is no longer true with Asia’s emergence. They do not share the US or Europe’s goals or time horizons. They are huge and are the future (in my opinion).

    Asia represents a structural change that will redefine the institutional rules in the global economy. I therefore posit that market signals cannot be interpreted as they could prior to Asia’s emergence. The market signals look ominous to those who seek the marginal logic and bullish who focus on growth metrics. I do not believe either is completely justifiable.

    I think that we need to rethink the use of nation-states as the aggregator of accounting. The emergence of multinationals seriously impacts this construct. In addition, debt is not held simply by nations. Consumers hold both assets and liabilities that they are charged with honoring. Brad and other have repeatedly pointed out that US consumers are taking on debt to fund consumption rather than investing.

  • Posted by gillies

    yes – it is easy to stick together when things are going well. also sticking together, as i see it, are the republicans and democrats. we hear a lot about democracy – but where is the opposition ? bush senior and bill clinton tour the east almost hand in hand. there seem to be so many openings for someone to run with the ideas of peace / diplomacy / negotiation over currencies and deficits / balanced budgets / etc. but no takers. the chinese get the jobs – the multinationals and hot money movers get the profits – and the lower middle class employees get to carry the can, serve in the military, and suffer declining standards of living. why is the left so weak ? in european countries some demagogue would by now be making hay, politically, with all that.

    and tell me this. i have these neat categories in my head – (chinese interests, u s interests, renminbi =chinese money, dollar = u s money) – but when gates and buffet are shorting america in the market, what kind of money is that ? are the beaches in the cayman islands big enough to hold all these people – if they become billionaires, personally, but are left as citizens of a country wrecked by their own exponential speculations ?

    also running happily together are multinationals’ ambitions for greater globalisation, and neo conservative ambitions to overawe the world with nationalistic military power. these two objectives might also part company at some stage. they are ultimately contradictory.

    if people really believed in globalisation, long term and all the way, they would by now be deliberately running down the u s military and investing in privately financed ‘ security’ armies. but now i am straying into fantasy . . . . . . . .

  • Posted by jm

    !! I left out the assumption _most_ problematic for the current topic:

    . – economic decisions are made by people who are
    . “playing with their own money”.

  • Posted by glory

    jen’s finally starting to come around 😀

    “A dilemma emerging. Similar to some OPEC members’ temptation to ‘cheat’, some members of this informal USD bloc have incentives to start diversifying before others do. There is no guarantee that the small to medium-size central banks will continue to keep their reserves in USD. Tokyo and Beijing are sensitive to the point that they cannot be seen as diversifying out of USD assets, due to their immense exposure to the USD and the Treasury. The problem is that South Korea and Taiwan also know this. This realisation creates a situation where the small and medium-size Asian central banks could try to diversify ahead of the large central banks, undermining the integrity of the de facto dollar zone and possibly triggering a generalised sell-off in the USD.”


  • Posted by glory

    How Diversified are Private Investors’ Portfolios?
    Rebecca McCaughrin (London)

    Central banks pale in importance to global financial markets compared to private investors. In the last three years, much attention has been devoted to the activities of foreign central banks. This is more a function of the growth in the reserves they manage, which rose by 8% over 2002, 15% in 2003, and 16% in 2004. In terms of the stock of outstanding assets, private investors are far more important for financial markets. Cross-border securities holdings by private investors totaled more than $12 trillion as of year-end 2002 according to the IMF, and could easily have grown to $15 trillion by year-end 2004 based on the growth in liabilities in the G-4 economies. That compares with just $3.7 trillion in the stock of official FX reserves at year-end 2004.

    How prominent are dollar assets in private portfolios? While the dollar is the preferred currency in central bank portfolios, international trade invoicing, and FX market turnover, we believe that private investors’ portfolios are more balanced. Private investors are nearly as willing to hold Euroland securities as US securities in their international portfolios. To calculate the weights of private holdings of foreign securities, we relied on the IMF’s coordinated portfolio investment survey (CPIS), an annual survey that tracks the portfolio assets and liabilities of 68 economies…

    Based on our pared-down sample of 38 countries, investment in US securities accounted for 30% of total foreign securities holdings, while Euroland securities represented 27%, the UK 17%, and Japan 6%, as of year-end 2002. More recent flow data in the G-4 show a similar distribution. These ratios imply that private investors already maintain well-diversified international portfolios…

    Bottom line: While the dollar reigns supreme as the world’s reserve currency and dominates in international trade invoicing and FX transactions, US assets do not enjoy the same superiority in private investors’ portfolios. Investors are nearly as likely to hold Euroland as US assets. While this suggests that large shifts by private investors are unlikely since they are not necessarily overweight US assets (in contrast to their central bank counterparts), even small shifts are potentially destabilizing, given that private investors’ portfolios are four times the size of central bank reserves. For this reason, while we concede that the risk of official diversification is a lingering concern and one that will continue to bolster the dollar bears, we should not dismiss the importance of private investors.