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Wednesday, September 1, 2010

East Asia’s Foreign Exchange Rate Policies

Michael F. Martin
Specialist in Asian Affairs

Financial authorities in East Asia have adopted a variety of foreign exchange rate policies, ranging from Hong Kong's currency board system which links the Hong Kong dollar to the U.S. dollar, to the "independently floating" exchange rates of Japan, the Philippines, and South Korea. Most Asian monetary authorities have adopted "managed floats" that allow their local currency to fluctuate within a limited range over time as part of a larger economic policy. A "crawling peg" is a special type of managed float in which a nation allows its currency to gradually appreciate or depreciate over time. China adopted a "crawling peg" policy from July 2005 to July 2008. 

U.S. policy has generally supported the adoption of "free float" exchange rate policies. Legislation has been introduced during the 111th Congress designed to pressure nations seen as "currency manipulators" to allow their currencies to appreciate against the U.S. dollar. However, most East Asian monetary authorities consider a "managed float" exchange rate policy more conducive to their economic goals and objectives. A "managed float" can reduce exchange rate risks, which can stimulate international trade, foster domestic economic growth and lower inflationary pressures. However, it can also lead to serious macroeconomic imbalances if the currency is severely over or under valued. In either case, a managed float usually means that the nation has to impose restrictions on the flow of financial capital or lose some autonomy in its monetary policy. 

Over the last five years, the value of the U.S. dollar has generally declined against most major currencies, although the U.S. dollar has partially rebounded against several major currencies since the beginning of 2010. The governments of East Asia have differed in their response to the fluctuations in the value of the U.S. dollar. Some have allowed their local currency to appreciate against the U.S. dollar; others have held the value of their currency against the U.S. dollar relatively unchanged. A few have seen their currencies depreciate in value relative to the U.S. dollar despite the weakness of the U.S. currency. 

Some Members of Congress and analysts maintain that the exchange rate policies of some nations are keeping the prices of their exports artificially low and the cost of U.S. exports artificially high, leading to a U.S. trade deficits with those nations. However, it is uncertain if the adoption of "free float" exchange rate policies in East Asia would necessarily lead to a major decline in the U.S. trade deficit with East Asia. Some studies have predicted significant trade effects from the appreciation of certain East Asian currencies; others show little or no impact. Recent trends in trade with China, Japan, and South Korea seem to indicate that exchange rates are not the pivotal factor determining bilateral trade balances.

Date of Report: August 16, 2010
Number of Pages: 12
Order Number: RS22860
Price: $29.95

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