East Asia’s Foreign Exchange Rate Policies
Michael F. Martin
Specialist in Asian Affairs
August 16, 2010
Congressional Research Service
7-5700
www.crs.gov
RS22860
CRS Report for Congress
P
repared for Members and Committees of Congress
East Asia’s Foreign Exchange Rate Policies
Summary
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.
This report will be updated as events warrant.
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East Asia’s Foreign Exchange Rate Policies
Contents
Types of Exchange Rate Policies ................................................................................................. 2
East Asia’s Exchange Rate Policies ............................................................................................. 3
Competitive Adjustments? .................................................................................................... 4
Exchange Rates and U.S. Trade............................................................................................. 6
Implications for U.S. Trade Policy in East Asia ........................................................................... 8
Figures
Figure 1. Changes in U.S. Dollar Exchange Rates for East Asian Currencies, July 2005 -
June 2010................................................................................................................................. 5
Figure 2. Currency Appreciation and U.S. Trade Growth with the China, Japan, and
South Korea, 2006 - 2010......................................................................................................... 7
Tables
Table 1. De Facto Exchange Rates Policies of East Asia (as of April 30, 2008) ............................ 3
Contacts
Author Contact Information ........................................................................................................ 9
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East Asia’s Foreign Exchange Rate Policies
he exchange rate policies of some East Asian nations—in particular, China, Japan, and
South Korea—have been sources of trade tension with the United States in the past and in
T the present. Some analysts and Members of Congress maintain that some countries have
intentionally kept their currencies undervalued for a period of time in order to keep their exports
price competitive in global markets. Some argue that these exchange rate policies constitute
“currency manipulation” and violate Article IV, Section 1(iii) of the Articles of Agreement the
International Monetary Fund, that stipulate that “each member shall avoid manipulating
exchange rates or the international monetary system in order to prevent effective balance of
payments adjustment or to gain an unfair competitive advantage over other members.”
Under U.S. law, the Secretary of the Treasury is required to conduct a biannual analysis of the
exchange rate policies of foreign countries and determine if they violate Article IV, Section 1.1 In
its report to Congress released in July 2010, the U.S. Treasury “concluded that no major trading
partner of the United States met the standards identified in Section 3004 of the Act during the
reporting period” (i.e. none was manipulating its exchange rate).2
Several bills have been introduced during the 111th Congress concerning the issue of “currency
manipulation” or “misalignment” in general. These include the Currency Exchange Rate
Oversight Reform Act of 2009 (S. 1254); the Currency Reform for Fair Trade Act of 2009 (H.R.
2378 and S. 1027); the End the Trade Deficit Act (H.R. 1875); the Trade Reform, Accountability,
Development, and Employment (TRADE) Act of 2009 (H.R. 3012); and Currency Exchange Rate
Oversight Reform Act of 2010 (S. 3134). While these bills address the exchange rate issue in
general, it is widely understood that the main targets are in East Asia, particularly China.
This report examines the de facto foreign exchange rate policies adopted by the monetary
authorities of East Asia. In some cases, there is a perceived discrepancy between the official (de
jure) exchange rate policy and the observed de facto exchange rate policy. This report will focus
primarily on the de facto exchange rate policies At one extreme, Hong Kong has maintained a
“linked” exchange rate with the U.S. dollar since 1983, under which the Hong Kong Monetary
Authority (HKMA) intervenes to keep the exchange rate between 7.75 and 7.85 Hong Kong
dollars (HKD) to the U.S. dollar.3 Such an arrangement is often referred to as a “fixed” or
“pegged” exchange rate. At the other extreme, Japan, the Philippines, and South Korea have
generally allowed their currencies to float freely in foreign exchange (forex) markets over the last
few years—an exchange rate arrangement often referred to as a “free float.” However, all three
nations—much like the United States—have intervened in international currency markets if
fluctuations in the exchange rate are considered too volatile and pose a risk to the nation’s
economic well-being.4 Most of East Asia’s governments, however, have chosen exchange rate
policies between these two extremes in the form of a “managed float.”
1 Section 3004 of the Omnibus Trade and Competitiveness Act of 1988 (P.L. 100-418), codified into U.S. Code
Chapter 22, Sections 5304-5306.
2 U.S. Treasury, “Report to Congress on International Economic and Exchange Rate Policies,” July 8, 2010, available
online at http://www.treasury.gov/offices/international-affairs/economic-exchange-rates/pdf/
Foreign%20Exchange%20Report%20July%202010.pdf.
3 For more information about Hong Kong’s exchange rate policy, see the HKMA’s web page: http://www.info.gov.hk/
hkma/eng/currency/link_ex/index.htm.
4 According to the Federal Reserve Bank in New York, the United States intervened in foreign exchange markets twice
between August 1995 and December 2006. For more information see http://www.newyorkfed.org/aboutthefed/
fedpoint/fed44.html.
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East Asia’s Foreign Exchange Rate Policies
Types of Exchange Rate Policies
There are a number of different types of exchange rates policies that a nation may adopt,
depending on what it perceives to be in its best interest economically and/or politically. At one
extreme, a country may decide to allow the value of its currency to fluctuate relative other major
currencies in international foreign exchange (forex) markets – a policy commonly referred to as a
“free float.” One advantage of a “free float” policy is that permits the nation more autonomy with
its domestic monetary policy. However, disadvantages of a “free float” policy include greater
exchange rate risk for international transactions, potentially destabilizing balance sheet effects,
and possible rapid shifts in capital flows.
At the other extreme, a nation may decide to fix the value of its currency relative to another
currency or a bundle of currencies – usually referred to as a “pegged” exchange rate policy.
Pegged exchange rate policies can take several forms. The pegged exchange rate may be set by
law, without special provisions to defend the value of the currency. Alternatively, a nation may
create a “currency board” – a monetary authority that holds sufficient reserves to convert the
domestic currency into the designated reserve currency at a predetermined exchange rate. The
currency board utilizes those reserves to intervene in international forex markets to maintain the
fixed exchange rate. For example, Hong Kong’s three designated currency-issuing banks – The
Bank of China, HSBC, and Standard Chartered Bank – must deposit with the Hong Kong
Monetary Authority sufficient U.S. dollar denominated reserves to cover their issuance of Hong
Kong dollars at the designated exchange rate of HK$ 7.80 = US$ 1.00. An advantage of a pegged
exchange rate is that it virtually eliminates exchange rate risk. Disadvantages are the loss of
autonomy in domestic monetary policy, potentially rapid changes in domestic prices (including
fixed asset values), and exposure to speculative attacks on the pegged exchange rate.
A third common exchange rate policy is a “managed float.” A nation that adopts a “managed
float” allows the value of its domestic currency to fluctuate in international forex markets until
such point that certain designated economic indicators reach critical levels. In some cases, the
country may designate a band around a determined exchange rate, and intervene in international
forex markets if the its currency hits the upper or lower value limits. One special form of a
managed float is a “crawling peg,” in which the nation allows its currency to gradually appreciate
or depreciate in value against one or more other currencies over time. China initiated a “crawling
peg” policy on July 21, 2005, which it maintained until the summer of 2008, a period in which
the renminbi appreciated 21% against the U.S. dollar. Other forms of managed float policies do
not rely on the exchange rate, but other economic factors such as the trade balance, current
account balance, inflation, and overall economic growth.
Contemporary economic theory asserts that a nation cannot simultaneously maintain a fixed
exchange rate, free capital movement, and an independent monetary policy. If a nation wishes to
peg its currency and allow free capital movement (for example, Hong Kong) it must tie its
monetary policy to that of the reserve currency nation (the United States). Many nations with
pegged exchange rates chose to restrict the movement of capital to allow them greater autonomy
in their monetary policies (such as anti-inflation measures, interest rate adjustments, or regulating
the money supply).
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East Asia’s Foreign Exchange Rate Policies
East Asia’s Exchange Rate Policies
Many East Asian governments have adopted “managed float” exchange rate policies. Table 1 lists
the current de facto exchange rate policies of East Asia according to the International Monetary
Fund (IMF) as of April 30, 2008, divided into four general categories: (1) Pegged; (2) Crawling
Peg; (3) Managed Float; and (4) Free
Float. Cambodia, China, Indonesia,
Malaysia, Singapore, Taiwan, Thailand,
Table 1. De Facto Exchange Rates Policies of
and Vietnam allow their currency to
East Asia (as of April 30, 2008)
adjust in value in forex markets so long as
Economy
Exchange Rate Policy
the fluctuations in value do not violate
some other economic policy goal (such as
Cambodia
Managed Float
inflation limits or money supply
China
Crawling Peg*
constraints). In addition, China and
Vietnam have officially adopted a type of
Hong Kong
Pegged
managed float known as a “crawling
Indonesia
Managed Float
peg”—that typically includes either the
Japan
Free Float
gradual appreciation or depreciation of
Laos
Managed Float
the currency over time against one or
more currencies.
Macau
Pegged
Malaysia
Managed Float
Categorization of a government’s
Philippines
Free Float
exchange rate policy can be complicated.
For example, according to South Korea’s
Singapore
Managed Float
central bank, the Bank of Korea, the
South Korea
Free Float
nation’s official exchange rate policy has
Taiwan
Managed Float
been a “free floating system since
December 1997.”5 However, it was
Thailand
Managed Float
reported that the South Korean
Vietnam
Crawling Peg*
government sold about $1 billion for won
on March 18, 2008, to stop a “disorderly
Source: International Monetary Fund, De Facto
decline” in the value of Korea’s currency.6
Classification of Exchange Rate Regimes and Monetary Policy
Framework, http://www.imf.org/external/np/mfd/er/2008/
There were also reports that Korea sold
eng/0408.htm.
more dollars for won in early April 2008.7
*Note: Status of exchange rate policies of China and
At the time, some forex analysts claimed
Vietnam subject to debate; some analysts think both
that the new South Korean government
nations have recently adopted a managed float.
had adopted a de facto pegged exchange
rate policy of holding the exchange rate
between the won and the U.S. dollar at 975-1,000 to 1.8 From the summer of 2008 to March
2009, the won sharply declined in value against the U.S. dollar, hitting a low of 1,569.61 won to
the dollar on March 3, 2009. Since then, the won has strengthened against the U.S. dollar, but was
still 15% weaker in June 2010 than it was in June 2005.
5 See the Bank of Korea’s webpage for a description of its exchange rate policy: http://www.bok.or.kr/template/eng/
html/index.jsp?tbl=tbl_FM0000000066_CA0000001186.
6 Yoo Choonsik and Cheon Jong-woo, “S. Korea Sold Dollars to Calm Markets-Dealers,” Reuters, March 18, 2008.
7 “Intervention Detected as S. Korea Won Pares Gains,” Reuters, April 4, 2008.
8 Yoo Choonsik, “S. Korea Won Hit by New Policy, Consumption at Risk,” Reuters, April 7, 2008.
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East Asia’s Foreign Exchange Rate Policies
Another source of complication arises when there is a seeming discrepancy between the official
exchange rate policy and observed forex market trends. For example, both China and Vietnam
officially maintained a crawling peg policy prior to the global financial crisis that allowed their
currencies—the renminbi and the dong, respectively—to adjust in value with respect to an
undisclosed bundle of currencies within a specified range each day. In theory, this allowed the
renminbi and dong to appreciate or depreciate in value gradually over time, depending on market
forces.
However, since the global financial crisis began in 2007, the renminbi has been comparatively
stable in value relative to the U.S. dollar. Initially, this led some analysts to assert that China had
abandoned the crawling peg in favor of a pegged exchange rate. Other analysts maintained that
the stability of the renminbi with respect to the U.S. dollar was an artifact of the bundle of
currencies being used by China. Because some major currencies have strengthened against the
U.S. dollar while others have weakened, the weighted average used by China in determining the
band for the crawling peg has resulted in a relatively unchanged value when compared to the U.S.
dollar. On June 19, 2010, China’s central bank, the People’s Bank of China, announced it would
“proceed further with reform of the RMB exchange rate regime and to enhance the RMB
exchange rate flexibility,” tacitly admitting that it had been intentionally maintaining a stable
exchange rate during the global economic downturn.9
Competitive Adjustments?
There are indications that some of the financial authorities monitor the region’s exchange rates
and attempt to keep the relative value of their currencies in line with the value of selected
regional currencies. These “competitive” adjustments in exchange rates are allegedly made to
maintain the competitiveness of a nation’s exports on global markets. For example, one scholar
maintains, “Countries that trade with China and compete with China in exports to the third market
are keen not to allow too much appreciation of their own currencies vis-à-vis the Chinese RMB
[renminbi].”10 The scholar, Taketoshi Ito, also speculates, “China most likely is more willing to
accept RMB appreciation if neighboring countries, in addition [South] Korea and Thailand, allow
faster appreciation.”11
An examination of East Asian exchange rates over the last five years (July 2005 to June 2010)
shows a full range of changes in exchange rates relative to the U.S. dollar (see Figure 1). Seven
currencies—China’s renminbi, Japan’s yen, Laos’ kip, Malaysia’s ringgit, the Philippines’ peso,
Singapore’s dollar, and Thailand’s baht—have appreciated between 17% and 28% against the
U.S. dollar over the last five years, albeit along different paths. Five currencies—Cambodia’s riel,
Hong Kong’s dollar, Indonesia’s rupiah, Macau’s pataca, and Taiwan’s dollar—were relatively
unchanged in value in July 2010 when compared to July 2005. Two currencies—South Korea’s
won and Vietnam’s dong—have lost nearly 20% in value over the last five years.
9 The text of the People’s Bank of China statement is available online at http://www.pbc.gov.cn/english/detail.asp?col=
6400&id=1488.
10 Takatoshi Ito, “The Influence of the RMB on Exchange Rate Policy of Other Economies,” paper presented at
Peterson Institute for International Economics Conference, October 19, 2007.
11 Ibid.
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Figure 1. Changes in U.S. Dollar Exchange Rates for East Asian Currencies, July 2005 - June 2010
(base value = June 2005)
40%
30%
20%
10%
0%
-10%
-20%
-30%
-40%
5
6
6
7
7
8
8
9
9
0
-06
-07
-08
-09
-10
ly-0
r-05
r-06
r-07
r-08
r-09
ry-0
ly-0
ry-0
ly-0
ry-0
ly-0
ry-0
ly-0
ry-1
Ju
Ju
Ju
Ju
Ju
tobe
April
tobe
April
tobe
April
tobe
April
tobe
April
anua
anua
anua
anua
anua
Oc
J
Oc
J
Oc
J
Oc
J
Oc
J
Cambodia
China
Hong Kong
Indonesia
Japan
Laos
Macau
Malaysia
Philippines
Singapore
South Korea
Taiwan
Thailand
Vietnam
Source: CRS calculations based on publicly available data.
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East Asia’s Foreign Exchange Rate Policies
Figure 1 also provides some support for the supposition that some nations are engaging in
competitive exchange rate management. The two pegged currencies—the Hong Kong dollar and
the Macau pataca—remained virtually unchanged throughout the time period considered, as
would be expected. Two of the currencies that have appreciated the most over the last five
years—the Laotian kip and the Chinese renminbi—appear to have followed a very similar path,
which is not surprising given Laos’ economic ties to China. The Malaysian ringgit and the
Singaporean dollar seem to have followed along the same path as the kip and renminbi until May
of 2008, when the ringgit and the Singaporean dollar began a year-long period of depreciation
against the U.S. dollar, followed by an uneven, gradual recovery to near the levels of the
renminbi.
In a similar fashion, the two currencies with the peak level of appreciation against the U.S. dollar
over the last five years—the free-floating Philippine peso and the managed float Thai baht—also
have fluctuated along comparable trend lines since July 2005. Another pair of currencies that
moved along similar paths since July 2005 were the Indonesian rupiah and the South Korean
won; both currencies depreciated against the U.S. dollar between 2005 and 2009, with the won
down by over 20%. The reasons for the apparent links between the four currencies are unclear.
Exchange Rates and U.S. Trade
There is a widely held notion that if a nation’s currency appreciates in value relative to other
nations’ currencies, its exports will tend to decline and its imports will tend to rise. In practice,
recent trends in U.S. bilateral trade in Asia have not always followed the expected patterns, as can
be seen by comparing recent U.S. trade flows with China, Japan, and South Korea (see Figure 2).
The three nations adopted different exchange rate policies between 2005 and 2009. China utilized
a “crawling peg” from July 2005 to July 2008, allowing the renminbi to appreciate against the
dollar by 21%, and then imposed an apparent peg for the rest of 2008 and 2009 in response to the
global financial crisis. Japan maintained its “free float” policy throughout the time period, during
which the yen initially weakened against the dollar and then strengthened by nearly as much as
the renminbi. South Korea, which usually maintains a “free float,” intervened in international
forex markets in 2008 and 2009 in an effort to stem a sharp decline in the value of the won
against the dollar. Overall, the renminbi and won strengthened against the dollar in 2006 and
2007, while the yen weakened. Then, in 2008 and 2009, the renminbi continued to strengthen, but
the yen and won switched directions—the yen strengthened and the won weakened.
Other factors aside, the expectation would be for U.S. exports to China to rise and its imports
from China to fall throughout the time period. For Japan, U.S. exports should have risen in 2006
and 2007, and then declined in 2008 and 2009, while U.S. imports should have dropped in the
first two years and then picked up in the second two years. In the case of South Korea, U.S.
exports should have gone down in 2006 and 2007, and then rebounded in 2008 and 2009, while
imports should have gone in the opposite direction.
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Figure 2. Currency Appreciation and U.S. Trade Growth with the China,
Japan, and South Korea, 2006 - 2010
(percentage change from 2005)
80%
60%
China
Japan
South Korea
40%
20%
0%
-20%
-40%
2006
2007
2008
2009
2006
2007
2008
2009
2006
2007
2008
2009
Percentage Change in US Exports
Percentage Change in US Imports
Exchange Rate Change
Source: CRS calculation based on USITC data and publicly available exchange rates
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East Asia’s Foreign Exchange Rate Policies
As shown in Figure 2, U.S. exports to China did grow from 2006 to 2008, but declined in 2009.
However, U.S. imports from China also increased from 2006 to 2009, and then decreased in
2009. U.S trade with Japan also did not follow the expected pattern. U.S. exports to Japan
steadily rose until through 2008 before declining in 2009 – a year later than expected. U.S.
imports from Japan rose in 2006, but then dropped in value from 2007 onward – nearly the
opposite of what the exchange rate effects would suggest. U.S exports to South Korea rose for the
first three years, and then dropped in 2009, which is contrary to predictions. U.S. imports from
South Korea also moved contrary to expectation, declining sharply in 2009 despite the weakening
of the won.
The implication is that exchange rates are not necessarily the pivotal factor determining changes
in bilateral trade between two nations. For example, the onset of the global financial crisis in
2007 is largely seen as being responsible for a global slowdown in economic growth and a
decline in international trade. It also contributed to significant shifts in exchange rates, as nations
faced liquidity problems and investors sought “safe haven” for their capital. Even in non-crisis
periods, economic factors other than exchange rates may affect trade flows.12
Implications for U.S. Trade Policy in East Asia
While U.S. policy has generally supported the adoption of “free float” exchange rate policies,
most East Asian governments consider a “managed float” exchange rate policy more conducive to
their overall economic goals and objectives. In part, East Asian governments may be resistant to a
“free float” policy because of the commonly held view in Asia that the economies with more
liberal exchange rate policies suffered more during the 1997-1998 Asian financial crisis than the
economies with pegged or managed exchange rates.13 As a result, there may be skepticism about
U.S. recommendations for adoption of “free float” exchange rate policies.
In addition, as indicated above, it is uncertain if the adoption of “free float” exchange rate policies
by more monetary authorities in East Asia would significantly reduce the U.S. trade deficits with
countries in the region.14 Among economists, there is no consensus that the resulting appreciation
of East Asian currencies against the U.S. dollar would either significantly increase overall U.S.
exports or reduce U.S. imports. However, for some price-sensitive industries where U.S.
companies are competitive, the appreciation of a competing nation’s currency may stimulate U.S.
export growth and/or a decline in U.S. imports.
12 These other forces may include the U.S. federal deficit, comparatively low U.S. interest rates, and/or various tariff
and non-tariff trade barriers. For more information, see CRS Report RL31032, The U.S. Trade Deficit: Causes,
Consequences, and Policy Options, by Craig K. Elwell.
13 For more about Asian views of the causes of Asian financial crisis of 1997-98, see Pradumna B. Rana, “The East
Asian Financial Crisis—Implications for Exchange Rate Management,” Asian Development Bank, EDRC Briefing
Notes, Number 5, October 1998; and Ramkishen S. Rajan, “Asian Exchange Rate Regimes since the 1997-98 Crisis,”
Singapore Centre for Applied and Policy Economics, September 2006.
14 In his abstract of his 2006 study, “The Effect of Exchange Rate Changes on Trade in East Asia,” Willem Thorbecke
concluded, “The results indicate that exchange rate elasticities for trade between Asia and the U.S. are not large enough
to lend confidence that a depreciation of the dollar would improve the U.S. trade balance with Asia.” Complete text of
paper available at http://www.rieti.go.jp/en/publications/summary/06030003.html. However, in a 2010 examination of
China’s trade with the United States, William Cline of the Peterson Institute for International Economics maintains that
a stronger renminbi will significantly reduce the U.S. trade deficit with China (a copy of his policy brief is available at
http://www.iie.com/publications/interstitial.cfm?ResearchID=1636).
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East Asia’s Foreign Exchange Rate Policies
Author Contact Information
Michael F. Martin
Specialist in Asian Affairs
mfmartin@crs.loc.gov, 7-2199
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