The case for an Asian Monetary Fund

Henry C K Liu

This article appeared in AToL on July 12, 2002

Some wonder about whether there should be a single currency for mainland China, Hong Kong and Macau. Indeed, the separate currencies for the two special administrative regions (SARs) are a legacy of Western colonialism and a transitional compromise accommodation of the "one country, two systems" formula. The arrangement has no economic rationale.

However, there is a broader question about monetary cooperation throughout East Asia, not just Greater China. It is a question that has been high on the Asian agenda since the regional financial crisis that began in 1997.

In 1978, China experimented with multiple currency arrangements in its special economic zones (SEZs): the renminbi (RMB, also known as the yuan), the Foreign Exchange Certificate, and the SEZ yuan. The result was considerable confusion and added transaction cost and friction. The arrangement was discontinued after three years. Chinese central bank chief Dai Xianglong has said he would "seriously consider" an International Monetary Fund (IMF) proposal to ditch the yuan link to the US dollar in favor of a link to a basket of currencies. Full convertibility and free float would come after that.

It is highly unrealistic to expect the Hong Kong dollar to be a functioning currency independent of the RMB for 45 more years, as mandated by the Basic Law. It is likely that Hong Kong would voluntarily adopt the RMB, or a currency with a close link to it, as soon as the RMB is freely convertible. Beijing has offered the option of a new currency as part of the negotiation for the reunification of Taiwan. A single currency for all parts of China, including Taiwan, does not constitute a regional currency, but a single national currency.

Although the yuan is officially pegged to the US dollar at 8.2: 1, its (and the dollar's) floating exchange value in relation to the Japanese 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 yuan to devalue against the dollar. Tokyo and Washington took steps to reverse the fall of the yen to avoid a yuan devaluation. Washington had put forth the notion that the Asian financial crisis of 1997 was precipitated by Chinese devaluation two years earlier of the RMB yuan from 5 to 8.2. Beijing 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 against other currencies, reflecting China's robust economy. Some have accused China of de facto devaluation through its rebate of taxes (20 percent) to exporters.

In 1996, about US$100 billion flowed into East Asia, but in 1997, $150 billion flowed out in the three months after July. Even though the Washington Consensus argued that domestic policies had caused the Asian financial crises that broke out in 1997, Asian governments have been looking to regional financial arrangements to protect themselves from similar volatility in the future. The most visible cause for the crises was the fixed-exchange-rate regimes adopted by Asian governments through the 1990s, all pegged to the US dollar at rates at odds with economic realities, alternatively too high and too low. The fixed exchange rates had to be defended by the central banks' foreign reserves earned from trade surpluses accumulated at the pegged exchange rates. As speculative attacks gathered force against the most vulnerable Asian currencies, several central banks found themselves drained of foreign reserves in short order, forcing them to abandon the fixed exchange rates. As local currencies devalued abruptly, 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, non-bank financial institutions (NBFIs) and securities markets, transparency in monetary and fiscal policies, payments settlements, corporate governance, 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 at the local level. On some of the eight dimensions, notably corporate governance and accounting and auditing standards, the United States is the leader of questionable practice. Yet the US dollar has been exempt from attacks from market forces, speculative or fundamental, because it is at once the preferred currency for international trade and a fiat currency that the US government can print at will. This contradictory dual status of the dollar is what gives it its hegemonic character.

The rapid pace of globalization has brought forth an urgent 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 foreseeable future because governments, except in such places as Hong Kong and Argentina, are reluctant to surrender national sovereignty in the protection of national economic interest. What then is the option facing individual governments? Already, the formation of the European Union, the North American Free Trade Area (NAFTA), Mercosur (Mercado Comun del Cono Sur, or Southern Cone Common Market) and other groupings demonstrate that other regions are moving ahead with regional arrangements. East Asia has lagged behind largely as a result of US geopolitical dictate.

The many market failures in the global financial regime, panics and herd behavior, have been well documented. Instead of dealing with the real problem, the international creditor community responds with IMF pressure. Not only will this approach not lift the financial yoke on emerging market economies, it is also unfair, because it imposes on these economies austerity measures they do 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 Group of Seven (G7) industrialized nations cannot agree among themselves on a common standard. Even after Enron and Global Crossing telecom IRU (indefeasible right of use of excess capacity) swaps and WorldCom accounting-fraud controversies, the United States 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 10 member countries of the Association of Southeast Asian Nations (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 to enable 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 $200 million to $1 trillion. The uniform framework of bilateral swap agreements between the three Northeast 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-swap agreements between South Korea and Japan, Malaysia and Japan and Thailand and Japan amounting to an additional $6 billion were signed. China and Japan signed a yen-yuan swap agreement in March 2001.

The CMI, which is a bilateral swap arrangement among 13 countries, achieved much more than expected. With monitoring and surveillance, it could be the beginning of an Asian Monetary Fund (AMF). The arrangement has already been in existence for two years and participating countries are working together on the regulatory arrangements.

The proposal of an Asian Monetary Fund initially received a cool response from the IMF and the G7, led by Washington, but their position has softened since. IMF managing director Horst Kohler has said that an Asian Monetary Fund would be acceptable if it were complementary to the IMF, and this has been echoed by the G7 and the Asia Europe Meeting (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 reform, 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 Asians 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 Basel Capital Accord is becoming more inclusive and East Asian participation is complete. Yet there is evidence that the Japanese banks' problems are caused largely by the "international" standards of capital requirements 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, the former Japanese vice finance minister for international affairs, is an initiator 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 in October 1997, which called on the Asian Development Bank to support Asian currencies that came under speculative attack with a special $100 billion fund to be provided by Japan.

The signatory governments of the 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 Eisuke). 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. It can also offer rescue packages more suited to Asian conditions than typical IMF conditionalties, which have been under serious criticism

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 inter-regional 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 (and political) collapse 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 interests 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 quickly. Hong Kong, with its huge US 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 1997-98 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.

After the 1997 financial crises, 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 after the crisis provides sufficient evidence to prove the point. Hong Kong suffered for its market liquidity more than for fundamental weakness. Regional investors sold in liquid Hong Kong markets to meet margin calls 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 were 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, intra-regional, 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 more 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 1 onward, 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 bilateral swap agreements between Japan and South Korea, Malaysia and Thailand have been finalized, thereby completing the first building block of the East Asian financial cooperation. By the end of 2001, comprehensive research had been done on the subject of capital-movement monitoring within the framework of ASEAN+3. By last month, two-way bilateral swap arrangements (TBSAs), or arrangements whereby China, Japan, and South Korea can financially assist one another in a reciprocal manner in times of similar needs, were also to have been instituted. The second building block in the framework of ASEAN+3 financial cooperation will be completed.

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. Any ASEAN+3 country 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 intra-regional 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 up front as well as the time frame involved in the operations; it would have sufficient size; and it would allow certain ASEAN member countries to benefit from the financing from the Northeast 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 CMI as a substantial step toward financial cooperation among East Asian countries. The objective is to complement existing international facilities by providing liquidity support for the nations in difficulty of international payment. According to Article 7 of the CMI, 10+3 finance ministers also mandated the ASEAN secretariat, on top of the currency-swap agreement, to work on an appropriate self-financing vehicle for the region with a view to strengthening the collective capacity against a possible future financial crisis.

East Asian cooperation has a strong political commitment, thereby creating a solid foundation and impetus for further development. In the face of the difficulties posed by the 1997 financial crises, 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 South 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 have 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 building 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 a regional financing mechanism symbolized by the CMI has been moving forward steadily while 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 meetings to summits and establishing an ASEAN + Northeast Asia Free Trade Zone. Moreover, the leaders of China, South Korea and Japan agreed to meet regularly on the occasion of the 10+3 leaders meeting since 2001.

Given their 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 imperialism and colonialism have fragmented Asia. The Cold War aggravated that fragmentation. Therefore, there is still a long way to go and arduous task faces these nations. 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. In contrast to other regional organizations that started from trade cooperation before their expansion, East Asian cooperation started from the financial field where they shared consensus before the comprehensive cooperative relations could be gradually established in the fields of finance, trade and investment.

East Asian cooperation has emerged along with the vigorous momentum of regionalization in the global economy, which is consistent with economic globalization. Globalization has two sides. 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 adequate 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.