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The euro crisis: Lessons for East Asia

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COMMENTS

29 November 2011 11:43

Only a few years ago, the European common-currency arrangements were held up as a possible model for Asia. With the euro under serious threat, we don't hear much about this now, but there may be some lessons for Asia from the current mess in Europe.

Lesson one might be surprising at first sight. It is that membership of a currency block is still seen as valuable. Ireland, Portugal and Greece seem ready to undergo years of wrenching austerity in order to stay in. Greece understands that in leaving the euro, it would be swapping one set of problems for another. Countries such as Turkey are still very ready to join.

Lesson two is more obvious: that it is hard to make common currencies work. Currency blocks work smoothly only if the member economies have a lot in common. There was always the promise (or hope) that membership would be the catalyst to make Greece more like Germany. But for Greece, there has been neither economic nor political convergence: continuing membership may yet prove unworkable.

Lesson three is an old one. Financial markets are prone to radical changes of risk assessment and lemming-like herding. They initially treated Greek debt as more-or-less on a par with German debt. When they belatedly perceived the reality, they pulled the plug.

Lesson four is that support mechanisms are needed when markets lose confidence. Even countries like Spain and Ireland, which have tried harder than the Greeks to be good euro-citizens, need external support. The euro arrangements have provided this, through loans and the support of the European Central Bank. There is a further sub-lesson here: when the crunch comes and confidence is lost, the supportive response is always tentative, inadequate and chaotic. Always too little, too late.

What are the implications for the emerging economies of East Asia?

Despite strong international advice after the Asian crisis to adopt freely floating exchange rates, a pure free float has not been adopted by any of these countries. They have managed their exchange rates, not only to smooth out volatility, but to resist appreciation pressures which would diminish their international competitiveness. As their production structures have become increasingly integrated through supply-chain frameworks, maintaining competitive parities with neighbours has become more important.

So far this maintenance of competitive parity has been an informal affair. It could be given more regional structure. If each country maintained stability (perhaps within a band) vis-à-vis a common basket of currencies which included a heavy weighting of Asian currencies, this would have some of the characteristics of the early stages of Europe's move to the euro.

This sort of structure creates tighter relativities but sets up potential vulnerabilities. In Europe, the euro's precursors — the 'snake' and the ERM — both broke down. Thus part-and-parcel of any tighter currency arrangements would be support arrangements of the type offered by the ECB. Emerging East Asian economies might get help from the International Monetary Fund, but many still carry bitter memories of the Fund's failures in 1997. The Chiang Mai Initiative is exactly the sort of arrangement which might do the job, but it proved unusable when it was needed in 2008 and in its present form provides only trivial support.

Asia might also heed the lesson that currency blocks should choose their participants carefully. One suggestion is that a smaller yuan-based grouping of ASEAN, China, Hong Kong and Taiwan might make more sense that a region-wide linkage.

All this leaves Asian exchange rates in an awkward policy space. The managed rates of the post-1997 period have worked well enough, but continued reserve accumulation is not sustainable, and running chronic current account surpluses is not optimal. Capital should be flowing 'downhill' to these emerging countries, not in the reverse direction. Establishing a stable range of relativities among a sub-set of the region might be a start in the right direction.

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