Monetary and Financial Cooperation in the Region (Summary)

In his opening remarks, Mr. NAKAJIMA Atsushi (Chairman, RIETI) explained that Mr. CHUNG Duck-Koo (Chairman, the NEAR Foundation) created the initiative to start this conference last year in Seoul and briefly introduced the mission of RIETI, which is to make policy proposals based on evidence from research activities. He then introduced and explained the theme of the conference, which is to discuss monetary and financial cooperation between the Association of Southeast Asian Nations & China, Korea, and Japan (ASEAN+3). He also expressed the importance of discussing the European economic crisis in relation to its impact on ASEAN+3 (A3).

Mr. CHUNG Duck-Koo mentioned that the importance of an Asian regional safeguard has been realized due to observations made of the European financial crisis. He expressed that a two-step approach of first establishing A3 cooperation, followed by integration with the rest of Asia, is the best way to proceed. He also mentioned that it is important to discuss whether or not the EU zone is an optimal currency area and how to go about actively utilizing the large potential A3 monetary reserve.

Prof. ITO Takatoshi (Faculty Fellow and Program Director, RIETI / Professor, the University of Tokyo) gave the keynote speech, which described issues facing Asian economic cooperation:

Asia is facing a tough time, and Asian economic and financial cooperation is losing momentum. On top of this, what was believed to be a good model in Europe is now crumbling down. It is disheartening to see that what Asia could possibly have become now no longer looks so realistic. Many have been working on regional cooperation since the Asian financial crisis of 1997, although it is difficult to be optimistic about the future of Asian economic cooperation.

The problems facing Europe are vast and worth discussing in order to give perspective on the situation in Asia. It appears that, at the heart of the problem, building economic cooperation on the basis of being beneficial for political unity is losing ground in Europe. Although it was known that economic integration among countries in different stages of development would be difficult, it was built with the vision that having political unity in order to avoid wars and conflicts on the European continent was more important. This vision seems to be losing support. Earlier this year in Berlin, policymakers and academics were saying that it was a mistake to admit Greece and that there seems to be no way to turn the situation around. This isn't something that was expected for European economic integration.

It appears likely that Greece could potentially exit the euro, and the other countries will stick together. The reason for Greece's exit is the lack of political will. Northern European countries will demand tough conditions, and once an extreme left government is established after the second election in June, it is likely that discussions will begin on Greece's departure. It seems plausible that what happened with Argentina in 2001-2002 will be repeated here.

Along with the difficulties involved in maintaining a common currency for countries in different stages of development, it is also hard to have a common currency with different fiscal authorities. This is another problem that Europe has faced. The eurozone average inflation target is close to 2%; however, in the 1990s, Spain and Ireland had a 5% inflation rate, whereas Germany had a 1.0%-1.5% rate. European Central Bank (ECB) officials argued that this was sustainable due to the Ballard Samerson effect and called it "convergence." In other words, it was argued that it is natural for high-growth countries to have higher inflation. Spain and Greece are now being blamed for allowing a "divergence" of unit labor cost. One solution would be to create a reverse of the 1980s, where Germany would have 5% inflation while Spain and Greece would have 0%. If Germany insists on 2% inflation for itself and the eurozone, this would mean that Spain and Ireland would have -3% or -5% deflation, which would result in the same problem that Japan faced in the past.

In the end, it appears that the problems in Europe are political. If Germany, France, and others in the eurozone had the political will to rescue Greece, they could have done it. Greece accounts for only 3% of the gross domestic product (GDP) of the eurozone, therefore providing a monetary safety net for it wouldn't have been a big problem. The crisis has been prolonged by conditionally giving small portions of money to Greece and forcing voluntary default. It is reasonable to believe that Germans would feel that it is unfair to give money to Greece unconditionally. Germans tend to retire later, have controlled wages, high work ethic, and high tax rates. This isn't the case in Greece. It would be difficult for Chancellor Merkel to agree to the unconditional rescue of Greece in the face of German taxpayers. It appears that European nations are more willing to help Spain, Italy, and Portugal, and furthermore, the European Financial Stability Facility's (EFSF) safety mechanism is in place, which could also massively help them. Therefore, there can still be hope that the eurozone will stick together after Greece's likely departure.

We have developed arguments in Asia that a fundamental crisis, or insolvency, must be addressed with stringent conditionality. Liquidity crises are caused by investors' panic and should be solved by a lender of last resort operation; therefore, the Chiang Mai Initiative (CMI) was created. The ASEAN+3 Macroeconomic Research Office (AMRO) was also established, which is useful in differentiating fundamental insolvency and liquidity crises. In summary, lessons learned from Europe are that it is a very tough challenge to coordinate financially with countries in different stages of development, and, more importantly, political will must exist to hold economic union.

The current status in Asia reflects a different set of problems. Unfortunately, it has been realized that the European model cannot be used successfully in Asia. We have very different monetary and exchange rate regimes and problems with movement of capital, labor, and technology. We have to accelerate free trade agreements (FTAs) in the region. In order for us to have free movement of capital, labor, and technology, not only tariff rates but also domestic institutions must be included, and we are far from this point.

Japan has a poor record in pursuing FTAs, while Korea appears to be the frontrunner in pursuing them. Korea now has FTAs with both the United States and Europe, and it appears to be doing a good job in realizing their benefits. Unfortunately, Japanese politicians can't seem to make rational decisions that would benefit the Japanese economy. Japan appears to have lost opportunities for FTAs with Korea and Australia, and it is very hesitant on the Trans-Pacific Partnership (TPP). There is a danger that Japan will be left out of all FTAs.

There are other challenges facing each of the A3 countries at the domestic level. Japan has fiscal problems that may potentially be worse than that of Greece. The government has been borrowing more than the tax revenue for four years, and it will soon hit a wall. Yet, politicians can't decide how to solve this problem. The consumption tax increase debated in the Diet this year is the first step in the right direction, although this seems to have diverted attention from the TPP and FTAs, which are currently not being debated in parliament. Both Korea and China will have a succession of power soon, and thus external relations may become secondary issues for a period of time.

Political will is another point worthy of consideration. It seems that the real problem in Asia is the same as that in Europe. From the Japanese perspective, the island issue with China was a turning point. After the Senkaku Islands incident, support has plummeted. If political support is not there, it is difficult to push economic cooperation. Internal to Japan's political problems are the last three to four years of political leaders. Prime ministers have been changed frequently. When the Democratic Party of Japan (DPJ) took power from the Liberal Democratic Party (LDP), there were high hopes for Mr. Hatoyama. He appeared to push a pro-Asia stance and put more effort into Asian relations than those with the United States. This sent a message that Japan wanted to be more independent from the United States. Unfortunately, he couldn't deliver anything concrete from changes in policy. He was a disappointment, and people lost trust in the new government. As a result, sadly, there is less enthusiasm in Japan for support of Asian economic cooperation.

We need to overcome difficult challenges, and this kind of conference is good for exchanging views and seeing that economic benefits exist for economic integration. It is hoped that political changes in China, Korea, and Japan will produce stronger governments in terms of economic rationality. From next year, new regimes could map out economic strategies for realizing the benefit of economic integration.

In the long run, we should put more effort into human capital and the next generation. Systems such as "Campus Asia," which harmonize China, Japan, and South Korea's colleges, should allow for the young generations to have a better understanding of and preparation for policy dialogue and mutual trust when they become leaders in 20 to 25 years. Although there are currently many problems to overcome, there is hope for the next generation and the future of Asian economic integration.

Prof. OGAWA Eiji (Faculty Fellow, RIETI / Professor, Hitotsubashi University) gave the first presentation which described the turbulence of the euro, mechanisms behind the global financial crisis, and the worsening of the worldwide fiscal balance:

Immediately after the introduction of the euro, its value was highly erratic. It depreciated during the IT boom in the United States (1999-2001) and then started to gain value after 2001 when the IT bubble burst. It continued to rise until mid-2008. The period from 2007 to mid-2008 is considered as the bubble of the euro due to the tight monetary policy of the ECB. At the start of the collapse of Lehman Brothers, the value of the euro dropped dramatically. However, there was also a similar decrease in the value of the U.S. dollar and the Japanese yen.

The global imbalance started in the late 1990s and was partly responsible for the global financial crisis in 2008. The U.S. dollar contradicted the start of the global crisis by increasing in value. The Asian countries created a surplus in their exported goods to match this increase. The U.S. dollar then crashed, losing substantial value due to international fiscal difficulty and an unstable housing market. The Asian market appeared immune to this crash due to government savings, however, a large amount of savings from Asian countries was invested in U.S. government bonds, causing instability in Asia when the dollar crashed. Once the housing bubble burst, it damaged the U.S. financial institutions, and, in turn, affected European financial institutions which played a role of international financial intermediation between the oil exporting countries and the United States.

The global financial crisis had two effects on the fiscal balances of advanced countries. First, financial institutions had their balance sheets damaged, which meant the governments had to give capital injection to them. Second, the global financial crisis brought about a worldwide recession. The G20 formed an international coordination in fiscal stimulus to try to counter the recession.

There is evidence that a recession happened in 2008 when several European countries were under fiscal deficits. The amount of debt in the eurozone shows that Greece is the worst financially in relation to GDP, but overall, it is not in the worst financial state. The interest rates in Europe were kept below the inflation rate, but after the revised fiscal deficit of Greece was announced, they abruptly increased, reflecting the sovereign risk.

Three measures should be implemented by Europe to help with the crisis: fiscal consolidation, restructuring of debts, and establishment of a financial safety net to prevent a crisis from contagion to other eurozone countries. Regional financial cooperation has been already in place in Asia due to the experience with the Asian currency and financial crisis of 1997. Reaction speed to financial crises is also essential. Delays in helping Greece caused the financial crisis to deepen in Europe. Japan, China, and Korea already closely monitor any capital surge and macroeconomic situtations through the surveillance process under CMI, which aims to strengthen regional financial cooperation to prevent any further crisis.

Prof. KIM Soyoung (Professor, Seoul National University) gave the second presentation, which summarized his paper on economic integration in Asia:

In recent years, we have observed two interesting changes in the Asian economies. After the Asian financial crisis, international economic linkages of Asian countries increased rapidly. Lowering trade barriers and forming FTAs promoted trade integration. Also, capital account liberalization and policy cooperation led to financial globalization. This rapid increase in economic integration progressed on both the global and regional levels. Another interesting phenomenon was the substantial increase in the business cycle comovements of Asian countries in the 2000s. Here, we examine the effects of economic integration on the business cycle comovements in Asia.

In contrast to past studies, we analyze the effects of various types of economic integration on the business cycle comovements. That is, we examine the effects of trade and financial integration separately. Furthermore, we examine the effects of internal integration within Asia and external linkages with the rest of the world separately.

We found that similar and strong external linkages have a significant positive effect on the business cycle synchronization of Asian countries. We also found that internal trade integration has a positive effect, but internal financial integration has a negative effect. This negative effect of financial integration is particularly interesting because many past empirical studies found a positive effect, in contrast to the theoretical prediction.

The results suggest that regional policy efforts on trade integration within Asia such as FTAs among A3 are likely to increase business cycle comovements of member countries. However, the regional efforts on financial integration within Asia, such as the Asian Bond Market Initiative (ABMI) and the Asian Capital Market Initiative (ACMI), may decrease the business cycle comovements within the region although they can affect them positively by increasing trade integration and can also increase comovements of the consumption growth rate. Whatever the effects of regional integration, similar and common external economic linkages play an important role in determining the business cycle synchronization within the region.

Dr. LONG Guoqiang (Director General, Research Department of Foreign Economic Relations, Development Research Center of the State Council) gave the third and final presentation about the causes of the European financial crisis and its global impact:

There are many explanations for the cause of the European financial crisis: the contagion effects of the financial crisis in the United States, high debt ratios, chronic trade deficits, increased labor costs, unsustainable social welfare, etc.

In Greece, the debt-to-GDP ratio has increased rapidly since it joined the euro. The debt-to-GDP problem is seen in other countries like Japan; however, they have not reached financial collapse. Japan's debt is mostly internal, which can be controlled by the government and the financial sector. In the case of Greece, it was mostly external, and thus it lacked control.

The real cause of the eurozone issue lies in the regional monetary arrangement which can not accommodate the regional development disparity within the area. The weak economies, most of which are in Southern Europe, can not adjust their international competitiveness by means of exchange rate depreciation, neither can they mitigate the increasing unemployment by relocating the unemployed labor nor by fiscal transfer from a "central government." The only way for the weak economies' governments are to borrow and accumulate debt. The real cause of eurozone debt crises is regional monetary integration without fiscal integration.

The European financial crisis is at a crossroad facing further integration (mainly fiscal integration) or the dismantaling of the euro. All of the remedies so far are febricide for the disease rather than its cure, therefore the crises will last a long time. While this uncertainty continues, the Asian economies will continue to feel its impact. Its three main impacts on the Asian market are: the increase of risk in Asian foreign exchange reserves, the loss of private investments in the European market, and the slowing of exports to the EU. The last point especially affects China as exports are key to its economy. The EU is the largest market for Chinese exports, thus the slowing of exports will eventually mean the same for economic growth in the country.

The euro crisis, however, does positively impact the Asian market. As prices are currently so low in Europe, Asian investors can buy companies and brands very cheaply. This will help growth in their economies and also allow new technologies to be introduced into their domestic markets.

The major implication for Asian monetary cooperation is that an "Asian dollar" may not be a good choice.

Prof. OGAWA Eiji briefly stated that he would be doing more research into the effects of the eurozone's crisis on China after the issue was raised.

Prof. KIM Soyoung made a short statement saying that there are some policy implications that are not fully covered by his paper, and he will study them in the future.

Dr. LONG Guoqiang talked briefly about how East Asian economies should promote regional cooperation in finances. He also stated that there is too much reliance on external markets in the Asian economies, which needs to be changed.

Dr. CHOI Gongpil (Senior Research Fellow, Korea Institute of Finance) gave the first presentation, which was on the management of foreign reserves:

One difficulty facing Asian economies is how to make the excessive financial reserves both useable and useful. We need to create new assets in order to secure financial stability in the Asian region. In order to do this, it would be best to use A3 currencies and not rely on U.S. dollar-denominated assets.

Hitherto, Asian economies have been working independently, but it has been realized that U.S. dollar-denominated assets can be risky. China, Korea, and Japan have been using vast resources to prevent a financial crisis; however, they are not being used efficiently. We would be better served by diversifying investments in order to remain intact in the face of potential financial crises and relying less on government funds. The proposed A3 fund could potentially provide emergency credit, and more importantly, help normalize the currently skewed global capital flow.

Although an A3 fund should be beneficial theoretically, it is a difficult proposition to deal with in actuality as there would have to be a reliance on a newly created legal framework and public confidence. After running tests on the Japanese, Chinese, and Korean currencies in order to see if they could potentially be internationalized, it would appear that none are able to satisfy all of the necessary requirements. One major reason why each country can't supply enough assets is the lack of market size.

In order to move forward, cooperation between the A3 nations is crucial. There should be no political motivations, and we should be frank about our status in order to make promises that can be delivered. We must find common ground upon which to agree and make proactive rather than no decisions and remain in a state of worry.

With regard to an agenda for institutionalization, it would be necessary to create a high court in order to deal with FTA-related disputes. Issues such as regional rebalancing of small and medium-sized enterprises and establishing a global climate fund could also be acted upon, although none of this will be possible without the formation of an A3 fund.

In conclusion, member nations of the Gulf Cooperation Council are presently discussing a future common currency, and they have an Arab Monetary Fund (AMF) and the Asian Clearing Union (ACU). With the Asian economy being vastly more important in comparison, there are no more excuses in further delaying progress.

Prof. SHIMIZU Junko (Professor, Gakushuin University / Project Member, RIETI) gave the second presentation, which was on the differences between the euro and the Asian Monetary Unit (AMU):

Before the European crisis, there were already talks of a common currency unit in Asia and South America, although this is now hard to promote due to the events that have occurred in Europe. As we realize that we won't continue to use the U.S. dollar as a key currency in East Asia, it is now a good time to discuss the next step to take. Furthermore, it appears that the economic surveillance of Asia is becoming very important.

It is worth describing the differences between the euro and the AMU. The differences are clear and apparent. To begin with, the euro is an official currency which came into effect as of January 1, 1999, and, as it is a single currency, it doesn't have the ability to adjust trade imbalances in the region. The AMU is just an artificial basket currency composed of the currencies of 13 East Asian countries. At the moment, the AMU is effectively similar to the European Currency Unit (ECU), what was the predecessor to the euro.

With regard to differences of currency regime in Europe and East Asia, many Asian countries keep capital controls, such as China, which act as an obstacle for high transaction costs in Asian currencies. The euro doesn't entail large foreign exchange risk, but without a monetary autonomy, its economy is facing a severe sovereign crisis.

As mentioned earlier, the AMU plays an important role as a surveillance indicator in the region. For example, watching the relationships of trade balance and the Asian Monetary Unit Deviation Indicator (AMUDI) is important. The AMUDI shows that the global financial crisis has had an asymmetric effect on Asian currencies and such movement is strongly related to the intraregional trade imbalance. Since the differences among Asian countries are still larger than those of the euro countries, we know that a fixed regime would not be suitable for the time being. We then need to decide on some rules for using the AMUDI as a surveillance indicator to stabilize the intraexchange rates.

It would seem that there are some important factors to consider in using the AMU as a surveillance indicator. It would be best to include only main currency countries, which account for 90% of the AMU, in the same band. Monitoring the surplus and deficit countries separately appears necessary.

In conclusion, setting up an A3 fund first would be the best course of action as well as an AMU for dealing with trade settlements and surveillance.

Prof. HE Fan (Deputy Director, Institute of World Economics and Politics, CASS) gave the third speech, which was on the ABMI and capital & financial regulations:

In Asia, we have accumulated a large amount of foreign exchange reserves and invested most of them in U.S. treasury bills. Thus, we are stuck in the dollar trap. In order to diversify our portfolio, we need to invest globally. With the rise of China, India, and other emerging economies, there will be an increase in the demand of energy, commodity, and agricultural products, and current investments in these areas are not sufficient. It is also important for Asian nations to invest in infrastructure, especially cross-border ones which link economically underdeveloped areas to growth centers.

Up until now, the ABMI hasn't developed fast for various reasons, including the underdevelopment of infrastructure and the lack of active involvement of the private sector. Closer cooperation is needed to develop the regional bond market further as well as the bond markets in the individual countries. It would also be beneficial to encourage the issuance of bonds denominated in local currencies and encourage the participation of private investors.

In principle, the A3 fund seems agreeable, but additional details need to be examined more carefully. For example, in order to establish the A3 fund, one scenario would be selling U.S. treasury bills, which would drastically affect the international financial markets. The U.S. dollar exchange rate would drop suddenly and probably cause panic in the market. Another scenario would be retaining U.S. treasury bills and creating a new reserve, although this would have to be based on the assumption that foreign exchange reserves can continue to accumulate.

In conclusion, it would be a good idea to both invest in infrastructure and make more global investments. The AMBI is anticipated to appreciate and internationalize, although there will be many challenges.

Dr. CHOI Gongpil made a short statement, pointing out that the money used to set up the A3 fund is a capital injection and a stepping stone to normalize global capital flow. He stated that we now live in a world where national barriers do not matter, especially in relation to financial transactions.

Prof. SHIMIZU Junko made a brief statement to the effect that the sequencing of integration in Europe and Asia is different. She mentioned that economic integration in Asia is promoted by the private sector, and that large corporations can use the AMU in order to invoice trade in the future.

Prof. HE Fan briefly stated that the idea of using the development of the Asian bond market to help small- and medium-sized enterprises sounds favorable. He also mentioned that distinguishing the three obstacles (convertibility, capital control, and exchange rate policies) in relation to the development of the Asian bond market would aid steps forward.

Coordinator OGAWA Eiji (Faculty Fellow, RIETI / Professor, Hitotsubashi University) introduced the topics to be covered in the panel discussion, which included management of the foreign reserves, differences between the euro and the ACU, and ABMI and financial regulations.

Prof. KIM Jung-Sik (Professor, Yonsei University) talked briefly about A3:

Most of the participants here would surely agree about the necessity of financial cooperation. Lessons learned from the European financial crisis have taught us the importance of cooperation and the development of the financial markets. However, it is important to know which options are feasible as each country is in a different situation, and there may be conflict among them. The A3 is also something worth discussing. It is a large market in an important area, but one problem is that Asian countries tend to have very divergent economies. One lesson from the European crisis is that convergence is very important. The A3 economies are less divergent, and it is believed that they would plausibly be a great success. We would like to discuss how the A3 nations could cooperate together and then expand internationally.

Prof. HE Fan asked Mr. CHUNG Duck-Koo to comment on what the opinion of the Korean government is on his proposal. Mr. CHUNG Duck-Koo made a short response:

It is hard to say how the Korean government thinks with regard to financial cooperation. Korea has long been in deep regret about existing trade barriers and is currently trying to enhance the network of foreign exchange trade regimes in the Asian region. The main objective of the FTA network is removing trade barriers, and the most important one is the different foreign exchange rates of each country. At first, the sequential steps of real economic integration through FTAs should be worked on, and following this, financial cooperation should be pursued. One concern is that if one big country has a predominant position in handling regional capital and bond markets, it can seriously affect interest rate policy or domestic macroeconomic policy formation. That is why the A3 should make a very well designed macroeconomic policy coordination institution. This is the limited information presently available on the opinion of the Korean government.

Prof. HE Fan also asked Prof. OGAWA Eiji to comment on the possible lack of enthusiasm from the Japanese government on financial cooperation and the ways to address this. Prof. OGAWA Eiji gave his response:

The Japanese government has a rigid stance on regional cooperation. Japanese politicians are changing over time, although it would be best to ask the ministry officials. In the case of trade, Japan is trying to move forward with a TPP with the United States and other countries. The Ministry of Foreign Affairs (MOFA) and the Ministry of Economy, Trade and Industry (METI) seem to be taking a parallel approach. Japan is also trying to create both an FTA with China and Korea, respectively, as well as a TPP that includes these two countries. The Japanese economy would be best suited to initiate a TPP with the United States and other countries, as it is a higher level, and an FTA with China and Korea. Japan's Ministry of Finance is taking the initiative to discuss financial cooperation in East Asia.

Prof. RHEE Yeongseop (Professor, Seoul National University) provided comments on A3:

The need for financial and exchange rate cooperation is frequently discussed. Asia has achieved rapid and long-lasting economic growth and has led the growth of the world economy. One of the key factors is exchange rate stability among the Asian currencies. Thus, for further prosperity in the region, a cooperation mechanism to ensure the stability of exchange rates among themselves is very essential. The ACU as a deviation indicator of currencies is becoming increasingly important. However, the correct use of the ACU as an indicator of Asian exchange rate deviation requires us to create an optimal version, which reflects well the values of the regional currencies. A consensus needs to be reached on how to compose the ACU and how to use the indicator for the stability among the Asian currencies. The A3 countries need to lead the effort.

Prof. OGAWA Eiji responded to Prof. RHEE Yeongseop 's comments on the desire for exchange rate stability:

The Japanese government and the private sector are in harmony with the Korean government in their desire to have exchange rate stability. The reason for this is that A3 countries with exchange rate stability would support the establishment of production networks.

Prof. OGAWA Eiji stated that, from the viewpoint of RIETI, they established a team that created the AMU and would like to propose something similar for A3. They would also like to calculate and analyze the differences between A3 economies through the use of the AMU in order to move forward. He expressed appreciation to the Chinese and Korean teams for joining the conference.

Mr. CHUNG Duck-Koo mentioned that, from the perspective of Korea, it is necessary to analyze the feasibility of financial cooperation among the A3 nations, rather than opinion-based or political discussion. He also expressed his appreciation for the preparation and organization of the conference, and looks forward to the next conference in Beijing.

Prof. HE Fan expressed his gratitude for the organization of the conference and to the Japanese and Korean counterparts for their interesting and enlightening insights. He also said that he looks forward to the next conference in Beijing.