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MACROECONOMICS

A Supranational Reserve Currency

The solution to reach global stability and avoid conflicts of interest

Supranational, Reserve Currency, solution, reach, global stability, avoid, conflicts of interest, macroeconomics, fx trader, forex

7 Aug 2015

The hypothesis most frequently cited as the cause of the global crisis centers on imbalances in the global economic and monetary system. In particular, large surplus countries caused tectonic market distortions by using their foreign reserves to purchase US Treasury bills. These purchases of government securities depressed interest rates in the US, which in turn sparked a debt-fuelled spending spree by the country’s consumers that ultimately resulted in housing and other bubbles in the US. Once the bubble finally burst, the US faced a major financial crisis that resulted in an economic crisis that rippled across the world. Potentially, this hypothesis is plausible. But what caused the large surpluses in China and other Asian countries? There are three commonly accepted theories.

The first one was the East Asian economies adopted an export-orientated strategy and, as a result of their exports, acquired large trade surpluses. The second common hypothesis is that East Asian economies learned a lesson in the 1998 crisis. They understood that if they did not have large enough foreign exchange reserves, their countries could once more be subject to speculative attacks. So for self-insurance, they started to accumulate reserves by exporting more. The third, and most widely accepted, hypothesis is that imbalances were the result of East Asian economies - and China, in particular - manipulating their foreign exchange rates.

Again, these hypotheses appear plausible, but do they stand up to an examination of the facts? Looking at the export-driven development hypothesis, we know that East Asian economies had adopted export-driven growth strategies since the 1950s and 1960s. For China, it started later, in the 1970s. Yet we know that before 2000, trade was basically balanced in East Asian economies, and some economies - such as South Korea - actually ran a trade deficit. So this kind of export-orientated strategy does not necessarily lead to huge surpluses and most east Asian economies did not have large trade surpluses until about 2000. It seems illogical to attribute a strategy that has been in use for more than half a century to explain what happened in just the last 10 years.

In the second hypothesis, all the East Asian economies increased their trade surpluses a lot and ramped up their reserves. But we also observed some other countries, such as Japan and Germany, substantially increasing their trade surpluses during the same period of time. But they did not have any particular motivation for accumulating reserves as a means for self-insurance. Since the yen is an officially sanctioned reserve currency, Japan would not need to stockpile foreign reserves against some form of speculative attack, yet its foreign reserves also grew.

The final hypothesis, that East Asian economies manipulated their exchange rates to increase their exports, also looks inconsistent. That’s because the trade surpluses of other competing economies should have been reduced. But the fact is that almost all other countries competing with East Asian economies also increased their trade surpluses and reserves. So there is an inconsistency.

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