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Section 5 “Imbalance” in the world economy <Section 5 Key points> ¾ The imbalance in the current account balances in the 21st century is expanding to record levels, as is evident from the over-concentration of the current account deficit in the U.S. and the expansion of the current account surpluses in East Asia as well as in the rest of the world with the exception of the U.S. ¾ The underlying causes of the imbalance concern the expansion of production and export bases in East Asia, which has resulted in economic growth dependent on foreign demand. The imbalance of the current account balances in East Asia is also illustrated by the expansionary trend of the region’s foreign exchange reserves. In terms of capital flow, it appears that the capital acquired through current account surpluses is channeled back into the U.S. and other developed countries by being invested into low-risk assets including U.S. Treasury bonds. ¾ While at this moment we cannot immediately envisage a situation in which the U.S. current account deficit cannot be promptly financed, it is true that its size is raising concerns about its sustainability. In order to overcome these concerns, it is necessary to achieve a sustainable and self-reliant economic growth in the East Asian region and shift from a unipolar structure dependent on U.S. consumption to a multi-polar structure including East Asia and Europe. 1. World economic trends and the over-concentration of the current account deficit in the U.S., from an international balance of payments perspective (1) Trends in the international balance of payments This section will examine the “expansion of the imbalance of the current account balances,” an acknowledged risk factor of the world economy in recent years. Figure 1.5.1 displays the trends in the current account balances by major countries and regions of the world economy. The figure shows that as the U.S. current account deficit expands, so does the current account surpluses of ten East Asian countries and regions, including Japan, NIEs, ASEAN4 and China. When the imbalance of the current account balances was drawing a lot of attention back in the 1980s, the overall situation was described in terms of the U.S. current account deficit and the Japanese current account surplus. In the 21st century, however, the imbalance is ascribed to the over-concentration of the current account deficit in the U.S. and the expansion of the current account surpluses in East Asia as well as in the rest of the world with the exception of the U.S.1 The growth engines driving the expansion of the world economy in the 21st century are the expansion of production and exports in the East Asian region, especially in China, as well as U.S. consumption and imports. Consequently, as illustrated in this figure, this new form of imbalance of the current account balances caused by the enormous U.S. current account deficit and the surpluses of entire East Asia is expanding into one of unprecedented size. The risks implicit in the two growth engines—the U.S. and Chinese economies—are both as described in earlier sections, and in this section, we will consider the expansion of the imbalance of the current account balances, a potential as well as structural risk.2 1 2 Yoshitomi (2004). It is possible that the rise of BRICS and high resource prices noted in earlier sections are also contributing to the -63- ($ billion) Figure 1.5.1 600 Trends in global current account balances 400 200 0 -200 -400 -600 US EU Japan NIEs ASEAN4 China BRICS (excluding China) Others -800 1980 1985 1990 1995 2000 2005 Source: World Economic Outlook Database September 2004 (IMF). (2) Financing of U.S. current account deficit The imbalance of the current account balances is sustainable as long as it can be financed by international capital. If we look at the other side and examine the large U.S. current account deficit and East Asia’s current account surpluses from the perspective of international capital flows, we see that the imbalance is nothing more than a mechanism of capital being exported from East Asia to the U.S. As shown in Figure 1.5.2, portfolio investment and other investment are sufficiently financing the U.S. current account deficit in terms of size. With regard to direct investment, however, the U.S. is a capital exporter. Aiming to further increase the rate of return on capital not used to finance the current account deficit, the U.S. channels the capital back into overseas countries in the form of direct investment. expansion of the imbalance of the current account balances. -64- ($ billion) 800 Figure 1.5.2 United States: Trends in balance of payments 600 Errors and omissions 400 Reserve assets 200 Inflow ↑ 0 ↓ Outflow Other investment balance Portfolio investment balance -200 Direct investment balance -400 Other capital account balance -600 Current account balance -800 1990 1992 Source: IFS (IMF). 1994 1996 1998 2000 2002 2004 Basic balances (3) International balance of payments and capital flows in East Asia Similarly, we take a look at the capital flow situation of nine East Asian countries and regions (NIEs, ASEAN4, China) excluding Japan from Figure 1.5.3. Although the current account balances of the entire aforementioned region were in deficits in 1995 and 1996 prior to the Asian currency and financial crisis (hereinafter referred to as “Asian crisis” in this section), the crisis was a turning point for establishing a surplus trend, which has been on an upturn since 2000. On the other hand, there was a great deal of capital inflow with respect to the financial account balance prior to the crisis, with surpluses in all three items of direct investment, portfolio investment and other investment. However, the outbreak of the Asian crisis led to excess outflow of other investment and a deficit trend for the entire financial investment balance. And from 2001 and onwards, direct investment inflows are being maintained, while the entire financial account balance is back to a surplus due to a gradual decline in the outflow amounts from portfolio investment and other investment. These sorts of circumstances largely contribute to rising foreign exchange reserves, and in East Asian countries and regions, the capital flow commensurate with the surplus portion of the current account balances is leading to a rise in foreign exchange reserves, which are on an expansionary trend. Furthermore, in recent years, the portion of the financial investment balance that turned into a surplus is contributing to rising foreign exchange reserves. -65- ($ billion) 300 Figure 1.5.3 Trends in international balance of payments in East Asian countries and regions (excluding Japan) 200 Errors and omissions Reserve assets Financial derivatives 100 Inflow ↑ 0 ↓ Outflow Other investment balances Portfolio investment balance Direct investment balance -100 Other capital account balance Current account balance -200 Basic balance -300 1990 1992 1994 1996 1998 2000 2002 2004 Notes: The graph shows the total value of balance items for each country and region. Source: IFS (IMF), Central Bank of China (Central Bank of China (Taiwan)), Fukui (2003). (4) Changes in capital flows among major regions Next, we examine the capital flows among each region. Figure 1.5.4 is a four-legged graph that illustrates the trends in capital flows of the U.S., Europe, Japan, and East Asia (excluding Japan), respectively, for 1996 and 2003 based on international balance of payments. According to this figure concerning the U.S. capital inflows, the U.S. current account deficit in 1996 was approximately US$120.2 billion, whereas the U.S. had inflows of US$101.4 billion from Europe and US$63.4 billion from Japan and outflows of US$500.0 million to East Asia (excluding Japan) in terms of financial investment balance. In other words, European and Japanese capital exports to the U.S. alone exceed the amount of the U.S. current account deficit. In 2003, however, the current account deficit was approximately US$530.7 billion, whereas inflows were US$36.6 billion from Europe, US$80.8 billion from Japan and US$139.1 billion from East Asia (excluding Japan). Therefore, from 1996 to 2003, the rapidly expanding U.S. current account deficit was also financed by capital from other countries and regions, with capital from East Asia including Japan largely contributing to the financing of the U.S. current account deficit. During this period, the East Asian economy achieved rapid economic growth in spite of the Asian crisis, and international capital flows also demonstrate the expanding presence of the East Asian economy. -66- Figure 1.5.4 International flow of funds (1996, 2003) (Unit: $100 million) US 1996 2003 Current Account Balance ▲1,202⇒▲5,307 Capital and Financial Account Balance 1,304⇒ 5,412 1996 2003 1996 US→Asia US→Japan Japan→US US→Japan Japan→US Direct Investment Portfolio Investment Other Investment Total Financial Investment Blance ▲3 58 ▲ 36 19 133 95 425 653 58 320 221 599 634 65 ▲ 55 1,397 1,407 808 1996 Direct Investment Portfolio Investment Other Investment Total Financial Investment Blance 2003 Asia→Japan Japan→Asia Asia→Japan Japan→Asia Direct Investment Portfolio Investment Other Investment Total Financial Investment Blance 4 33 ▲ 30 7 97 21 ▲5 113 106 Japan 1996 2003 Current Account Balance 658⇒ 1,362 Capital and Financial Account Balance ▲313⇒ 679 4 ▲1 ▲ 179 ▲ 176 50 ▲5 ▲ 383 ▲ 338 2003 Asia→US 138 251 139 528 ▲7 50 480 523 US→Asia 1996 US→EU Asia→US 159 120 119 398 ▲5 ▲3 448 1,344 1,789 1,391 Direct Investment Portfolio Investment Other Investment Total Financial Investment Blance 362 733 748 1,843 2003 EU→US 531 605 1,721 2,857 US→EU EU→US 814 145 862 1,821 115 1,077 995 2,187 1,014 366 East Asia (excluding Japan) 1996 2003 Current Account Balance ▲219⇒1,646 Capital and Financial Account Balance 971⇒ 124 N.A. ▲ 162 1996 2003 EU→Japan Japan→EU EU→Japan Japan→EU Direct Investment Portfolio Investment Other Investment Total Financial Investment Blance 8 660 ▲ 349 319 32 224 ▲ 252 4 ▲ 315 54 430 75 559 80 729 ▲ 898 ▲ 89 ▲ 648 E.U.(15) 1996 2003 Current Account Balance 861⇒ 578 Capital and Financial Account Balance ▲55⇒ ▲809 Notes: 1. US Department of Commerce data used for investment balance for US-Japan, US-East Asia and US-EU; Bank of Japan data used for Japan-East Asia, Japan-EU. 2. The US-East Asia data was obtained by subtracting the “South Africa” data from “Other countries in Asia and Africa” data. 3. “Other investment” of Japan-East Asia and Japan-EU was obtained by aggregating “Other investment” data and “Financial derivatives” data. 4. The value for current account balance and capital and financial account balance for East Asia (excluding Japan) and EU (15) was the aggregate of each country’s value in the IFS. Source: IFS (IMF), U.S. International Transactions Accounts Data (US Department of Commerce), Regional Balance of Payments (Bank of Japan), Central Bank of China (Republic of China (Taiwan) )Website, Fukui (2003). 2. Rising foreign exchange reserves in East Asia (1) Rapidly rising foreign exchange reserves in East Asia As stated earlier, East Asian foreign exchange reserves are increasing significantly in tandem with the expansion of its current account surplus. Here, we examine the foreign exchange reserves in East Asia. Figure 1.5.5 illustrates the trends in foreign exchange reserves of East Asian countries and regions. The figure shows that foreign exchange reserves are rapidly increasing, with those of China nearly tripling over a three-year period from the end of 2001 to the end of 2004. -67- ($ billion) Figure 1.5.5 Trends in foreign exchange reserves in East Asian countries and region (excluding Japan) 600 500 400 China South Korea Taiwan Hong Kong Singapore Thailand Malaysia Philippines Indonesia 300 200 100 0 1990 1992 1994 1996 1998 Sources: IFS (IMF), Central Bank of China (Central Bank of China (Taiwan)). 2000 2002 2004 In addition, Figure 1.5.6 illustrates the ratio of East Asia’s foreign exchange reserves to global foreign exchange reserves. At the end of 2004, the total foreign exchange reserves of ten East Asian countries were roughly US$2.3 trillion, which account for approximately 59% which is more than half of the global foreign exchange reserves. Relative to economic size, the level of the current account surplus and foreign exchange reserves of East Asian countries and regions excluding Japan far exceeds that of Japan. For example, in 2003, while the current account surplus to GDP ratio was roughly 3% in Japan, Singapore had a high ratio of 30% as well as other countries including Hong Kong, Taiwan and Malaysia recording over 10%. With respect to foreign exchange reserves also, while Japan holds the most foreign exchange reserves in the world, its foreign exchange reserves to GDP ratio is roughly 18%. In contrast, there are quite a number of other East Asian countries and regions with foreign exchange reserves to GDP ratio of over 30% (Table 1.5.7).3 3 Yoshikuni (2003). -68- ($ billion) 4,000 3,500 3,000 Figure 1.5.6 East Asia: Trends in foreign exchange reserves Global foreign exchange reserves (end of 2004) Foreign exchange reserves Of total global reserves ($ billion) (%) Japan 833.9 21.6% NIEs 676.5 17.6% ASEAN4 162.9 4.2% China 614.5 15.9% East Asia Total 2,287.8 59.4% World Total 3,853.7 100.0% 2,500 2,000 1,500 1,000 ASEAN4 China Others NIEs 500 Japan 0 1980 1982 1984 1986 1988 1990 1992 Source: IFS (IMF), Central Bank of China (Republic of China (Taiwan)) Website. 1994 1996 1998 2000 2002 2004 Table 1.5.7 Size of foreign exchange reserves and current account balances (percent of GDP) (%) Current account balance/percent of GDP Foreign exchange reserves/percent of GDP 1996 2003 1996 2004 South Korea -4.16 2.04 6.10 29.24 Taiwan 3.91 10.23 31.48 79.16 Hong Kong 10.68 40.75 75.05 Singapore 15.07 30.86 83.34 105.06 Thailand -8.07 5.56 20.74 32.28 Malaysia -4.42 12.97 26.78 56.36 Philippines -4.77 4.16 12.11 14.95 Indonesia -3.37 3.62 8.03 13.57 China 0.89 3.25 13.11 37.26 Japan 1.40 3.17 4.62 17.87 Source: IFS (IMF), Key Indicators 2004 (ADB), Central Bank of China (Central Bank of China (Taiwan)), Foreign Economic Data (Cabinet Office). (2) Investment of foreign exchange reserves4 How are rapidly expanding foreign exchange reserves being invested? Using data from the International Monetary Fund (IMF), among other sources, we can ascertain the investment composition ratio by currency and the ratio of portfolio investment (Table 1.5.8 and Table 1.5.9). From the tables, we can see that 59.3% or nearly 60% of the foreign exchange reserves in developing countries, which include many East Asian countries and regions, were denominated in US dollars in 2003. Moreover, an increase in the ratio of Euro-denominated foreign exchange reserves is also witnessed in recent years. Next, if we look at the ratio of portfolio investment, we can see that foreign currency securities make up a relatively large share of 60-90% of the foreign exchange 4 Shimizu and Murata (2005). -69- reserves in East Asian countries and regions. Table 1.5.8 Trends in foreign reserves composition ratio by currency (Unit: %) Total for all member countries 2000 2001 2002 2003 US $ 66.6 66.9 63.5 Japanese yen 6.2 5.5 5.2 British pound 3.8 4.0 4.4 Swiss franc 0.5 0.5 0.6 Euro 16.3 16.7 19.3 Others 6.6 6.4 7.1 Notes: The data is based on IMF member countries. Source: IMF Annual Report 2004 (IMF). 63.8 4.8 4.4 0.4 19.7 6.8 Total for developed countries 2000 2001 2002 72.5 6.3 2.0 0.2 17.2 1.8 72.7 5.6 1.8 0.3 17.5 2.1 Total for developing countries 2000 2001 2002 2003 69.1 4.6 2.2 0.6 21.3 2.2 70.8 4.0 1.7 0.2 20.9 2.3 62.2 6.1 5.1 0.7 15.6 10.2 62.9 5.4 5.4 0.6 16.2 9.4 59.8 5.5 5.8 0.6 17.9 10.4 2003 59.3 5.2 6.2 0.6 18.9 9.8 Table 1.5.9 Ratio of foreign currency securities in foreign exchange reserves for East Asian countries and regions (end of 2004) Japan Foreign reserves (a) 844,543 South Korea Hong Kong Singapore 199,066 123,569 Thailand 112,808 49,832 (Unit: $ million) Malaysia Philippines Indonesia 66,209 16,029 36,320 Foreign currency 699,398 167,430 113,269 100,717 34,755 45,382 8,932 27,476 securities (b) Percentage of portfolio 82.8% 84.1% 91.7% 89.3% 69.7% 68.5% 55.7% 75.6% management (%) (b/a) Notes: The table used the data from the end of 2004 based on the Special Data Dissemination Standard from the IMF website. Source: Each country's central bank website. We can thus deduce that foreign reserves are also reserve assets by nature and are invested primarily in highly safe and liquid U.S. dollar-denominated assets including U.S. Treasury bonds. Table 1.5.10 shows a breakdown of U.S. Treasury bonds held overseas by country. In 2004, seven East Asian countries and regions held a total of US$1.1291 trillion worth of U.S. Treasury bonds, more than double what they held in 2000. If we assume that the share of U.S. Treasury bonds held by the public sector is equivalent to the world average of approximately 60%, this would mean that an enormous sum of capital totaling approximately US$680.0 billion is invested in U.S. Treasury bonds. It is believed that a considerable amount of investment capital from foreign exchange reserves is included in the sum. From the above assessment of the foreign exchange reserves’ investment patterns, we can extrapolate that the capital acquired from the current account surplus is invested in low-risk assets that are highly safe and liquid such as U.S. Treasury bonds through foreign exchange reserves. One way of looking at the situation is that foreign exchange reserves are in the end financing the U.S. current account deficit. This view is also consistent with the trend demonstrated from international capital flows that we stated earlier. Table 1.5.10 Trends in US Treasury Bond reserves in East Asian countries and regions 2000 Percentage (%) 2001 China 60.3 5.9% 78.6 South Korea 29.6 2.9% 32.8 Taiwan 33.4 3.3% 35.3 Hong Kong 38.6 3.8% 47.7 Singapore 27.9 2.7% 20.0 Thailand 13.8 1.4% 15.7 Japan 317.7 31.3% 317.9 521.3 51.3% 548.0 Total of seven countries and regio Total of foreign reserves 1,015.2 100.0% 1,040.1 Foreign public sectors 609.2 60.0% 619.4 Source: Treasury Bulletin (US Ministry of Finance), Fukui (2003). 2002 118.4 38.0 37.4 47.5 17.8 17.2 378.1 654.4 1,238.6 763.1 -70- 2003 157.7 62.9 51.4 49.8 21.3 11.7 551.4 906.2 1,525.7 938.2 (Unit: $ billion) 2004 Percentage (%) 2004/2000 (times) 193.8 10.0% 3.21 times 69.0 3.6% 2.33 times 58.8 3.0% 1.76 times 52.7 2.7% 1.37 times 28.0 1.4% 1.00 times 15.0 0.8% 1.09 times 711.8 36.8% 2.24 times 1,129.1 58.3% 2.17 times 1,935.9 100.0% 1.91 times 1,172.9 60.6% 1.93 times (3) Foreign exchange reserves5 Foreign exchange reserves refer to “capital to be used by monetary authorities for exchange intervention as well as reserve assets to be used when the repayment of foreign currency-denominated debt to other countries is difficult due to currency crises, etc., (Bank of Japan website).” In other words, to a certain degree accumulation of foreign exchange reserves is believed to be necessary for currency stabilization in that country. East Asian countries and regions in particular have a history of advancing foreign exchange reserve accumulation to insure against a currency crisis, having experienced a large shock, namely the Asian crisis. As such, the following paragraph will consider the size of rapidly increasing foreign exchange reserves in East Asian countries and regions in recent years.6 Given that there are various theories on the optimum level of foreign exchange reserves and that a uniform indicator does not necessarily exist,7 in this paragraph the optimum level will be introduced in reference to comparisons with import value and short-term debt which are also analyzed by the IMF (2000), among others, to evaluate foreign exchange reserves from a practical perspective. 8 First, the “foreign exchange reserves/import value” illustrates for approximately how long foreign exchange reserves are able to finance imports, and as a rough measure, it is indicated that more than three-months worth of imports is necessary. In this respect, the figures expressing the import value ratio in Table 1.5.11 are increasing overall compared to immediately before the outbreak of the Asian crisis, with the ratio greatly exceeding the three-months worth of imports, the ratio being more than six-months for countries other than the Philippines and Hong Kong.9 Secondly, the “foreign exchange reserves/short-term debt” illustrates the ability of foreign exchange reserves to finance the debt whose payment will be due in a year in which external financing becomes difficult, and one year is used as a benchmark.10 As we can see from the figures, while there were a sparse number of countries and regions whose foreign exchange reserves were well below their short-term debts in 1996, as of 2003, the foreign exchange reserves of all countries and regions were over 1.0 times the short-term debts. In fact, all countries and regions excluding the Philippines achieved ratios of over 1.5 times, and we can therefore infer that the short-term debt ratio is largely improving. 5 This section is particularly based on Otani and Watanabe (2004). A theoretical study of foreign exchange reserves includes the buffer stock model, a decision theory of optimal foreign exchange reserves (Otani and Watanabe (2004)). 7 According to Yoshikuni (2003), there is no agreement on the optimal level of foreign exchange reserves even among experts. 8 Aside from import value and short-term debt, the IMF (2000) gives “foreign exchange reserves/money supply,” etc., as an indicator illustrating the impact of capital flight initiated by residents as an evaluation method. 9 According to IMF (2000), as a rough measure, the ratio of “foreign exchange reserves/import value” must be at least three months. 10 IMF (2000) points out that while it defines the benchmark for the ratio of “foreign exchange reserves/short-term debt” to be 1.0 times, this is not absolute given that Malaysia suffered from the Asian crisis in spite of having a high ratio of 1.5 as of 1997. Also refer to IMF (2003). 6 -71- Figure 1.5.11 The ratio of foreign exchange reserves to import value and to short-term external debt Foreign exchange reserves ($ million) 1996 2002 2003 2004 Countries which experienced the Asian financial crisis Korea 34,037 121,345 155,284 198,997 Thailand 37,731 38,046 41,077 48,664 Malaysia 27,009 34,222 44,515 66,384 Philippines 10,030 13,136 13,457 12,917 Indonesia 18,251 30,971 34,962 34,952 Other East Asian countries and regions China 107,039 291,128 408,151 614,500 Taiwan 88,038 161,656 206,632 241,738 Hong Kong 63,808 111,896 118,360 123,540 Singapore 76,847 82,021 95,746 112,232 Foreign exchange reserves/import value (number of months) Foreign exchange reserves/short-term debt (multiple of increase) 1996 2002 2003 2004 1996 2002 2003 2.7 6.3 4.1 3.7 5.1 9.6 7.1 5.2 4.4 11.9 10.4 6.6 6.4 4.3 12.9 10.6 6.1 7.6 3.8 9.1 0.46 0.76 2.03 1.11 0.49 2.59 3.38 3.16 1.60 2.00 2.74 3.55 3.74 1.12 2.23 9.3 10.3 3.9 7.0 11.8 17.2 6.5 8.5 11.9 19.5 6.1 9.0 13.1 17.3 5.5 8.2 3.34 4.32 0.36 0.43 10.23 10.12 1.91 1.38 10.16 7.42 1.64 1.58 Notes: 1. The foreign exchange reserves are figures for the end of each year from the IFS (IMF) and Central Bank of China (Republic of China (Taiwan)) Website. 2. Import value is 1/12 of the import value data for the reference year from the Foreign Economic Data (Cabinet Office). 3. Short-term external debt which is due within a year is based on the Joint-BIS-IMF-OED-World Bank Statistics on External Debt. Specifically, it sums the stock data of “Liabilities to banks,” “Debt securities issued abroad,” and “Non-bank trade credits” (at end of the year.) The figures for 2004 have not been disclosed (as of April, 2005). Source: Statistics on External Debt (Joint BIS-IMF-OECD-WB), IFS (IMF), Central Bank of China (Republic of China (Taiwan)) Website, Foreign Economic Data (Cabinet Office). 3. Implication of expanding current account surplus in East Asia The Asian crisis triggered the current account surpluses in East Asia, and they are on a further expansionary trend even now when seven to eight years have passed since the crisis. One underlying factor is the weak exchange rates in East Asian countries and regions compared to pre-crisis rates11 (Figure 1.5.12 and Figure 1.5.13). East Asian countries and regions shifted to a floating exchange rate regime following the Asian crisis, and in some respects, their dollar buying intervention aimed at stabilizing their exchange rates against the dollar resulted in the accumulation of foreign exchange reserves.12 Also, on the other hand, IS balance theory supposes that the size of current account balances is always equivalent to the difference in savings and investment amounts of that country, and so the Asian crisis also triggered changes in the savings and investment balance of East Asian countries and regions. Hence, another import cause of the current account surplus is the shift from excess investment to excess savings in East Asian countries and regions.13 This point will be further elaborated in Section 4, Chapter II. 11 Yoshitomi (2004) indicates that the weakening real effective rates in the face of good fundamentals in East Asia is one factor leading to the current account surpluses. 12 The Ministry of Finance (2002) and Fukuda and Hakari(2001) point out that the shift to a floating exchange rate regime raises the linkage between the exchange rates of East Asian countries and regions and the U.S. dollar. 13 Fukui (2003). -72- (1996=100) 50 Figure 1.5.12 Trends in nominal currency exchange rate Korean wong Hong Kong dollar Thai baht Philipino peso Japanese yen Taiwan dollar Singapore dollar Malaysian ringgit Chinese yuan Indonesian rupiah (right scale) ▲ 50 Chinese yuan Hong Kong dollar 100 150 100 Strong currency (Weak dollar) ↑ ↓ (Strong dollar) Weak currency 250 200 400 250 1995Q1 1996Q1 1997Q1 1998Q1 1999Q1 2000Q1 2001Q1 2002Q1 2003Q1 2004Q1 2005Q1 Notes: For US$1 for each currency value, the values are indexed with 1996 being 100 for every quarterly average. Source: Bloomberg. 550 (1996=100) Figure 1.5.13 Trends in real effective exchange rates 125 100 75 50 25 1995Q1 Currency appreciation ↑ ↓ Currency depreciation 1996Q1 1997Q1 1998Q1 1999Q1 Korean wong Taiwan dollar Hong Kong dollar Singapore dollar Thai bahts Malaysian ringgit Philippion peso Indonesian rhupia (right scale) Chinese yuan Japanese yen 2000Q1 2001Q1 2002Q1 2003Q1 2004Q1 2005Q1 Notes: The data is indexed with 1996 being 100 by calculating quarterly averages from every monthly average. Source: JP Morgan Index (JP Morgan website). -73- In summary, the economic growth of East Asian countries and regions is largely contributing to the expansion of the imbalance of the current account balances in the 21st century. The expansion of production and export bases in East Asian countries and regions has resulted in economic growth dependent on foreign demand and is identified as one of the causes of the expansion of the imbalance of the current account balances in the 21st century. The imbalance in East Asian countries and regions is clearly illustrated by the expansionary trend of foreign exchange reserves, and in terms of capital flow, the capital acquired from current account surpluses is channeled back into the U.S. and other developed countries by being invested into low-risk assets including U.S. Treasury bonds. As for the outflow of East Asia’s foreign exchange reserves to developed countries’ low-risk assets, one argument is that East Asian countries and regions are investing their foreign exchange reserves in developed countries’ safe assets with low rates of return out of necessity, as the capital markets in their country or region are not developed. Therefore, it is argued, the outflow is the difference in terms of the country’s or region’s rate of return on risky assets that these countries and regions can normally enjoy and they are compelled to pay this amount to developed countries in the form of a certain premium (Fukui (2003)). Meanwhile, it is pointed out that the savings of East Asia are not leading to the mid- to long-term investment capital that is necessary for economic development. As a solution to these concerns, it is important to develop a capital market within the region, among other measures, and in order to overcome these challenges, the Asian Bond Market Initiative (ABMI) and the Asian Bond Fund (ABF) initiative are being proposed. In addition, international cooperative initiatives including the Chiang Mai Initiative which is being advanced in East Asia may be considered as an effort to reduce the desired level of foreign exchange reserves in East Asian countries and regions. Chapter III will again take a look at these regional initiatives aimed at economic cooperation. This section showed that the current U.S.-led growth mechanism of the global economy is resulting in the imbalance of the current account balances. As stated earlier, while at this moment we cannot immediately envisage a situation in which the U.S. current account deficit cannot be promptly financed, it is true that its size is raising concerns about its sustainability. Overcoming those concerns will require a shift from a unipolar structure dependent on U.S. consumption to a multi-polar structure including East Asia and Europe. This and the sustainable and self-reliant growth of East Asia will be analyzed from Chapter II and onwards. -74-