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Is the accumulation of reserves in East Asia the consequence of deliberate undervaluation of the corresponding currencies leading to large current account surpluses, or is it due to the need for the United States to finance its external imbalance, or yet again to capital inflow in the region in anticipation of currency revaluations? Will appreciation of the renminbi by itself be a solution to the Unites States’ external imbalance? If not, what policies would? What will happen to long term interest rates and exchange rates if a more flexible exchange rate system in China leads to some diversification of international reserve holdings away from the US dollar towards the euro or the yen? The seventh title in the ICMB/CEPR series of Geneva Reports on the World Economy addresses these questions and reaches the following conclusions:

• The reserve build up is not driven by deliberately undervalued exchange rates. Recent increases in reserves have been the result more of capital inflows than of current account surpluses. In these circumstances it may be appropriate to intervene in the foreign exchange market to prevent a sharp appreciation that would have the potential to cause domestic deflationary pressures.
• Autonomous exchange rate adjustment is not an efficient method to deal with current account imbalances between the United States and East Asia. These imbalances are due to suppressed investment rates in Asia (outside China) and low savings in the United States. Expenditure increasing/reducing policies on a global scale are necessary to restore balance to the global economy.
• The reform of the exchange rate system in China may over time lead to reserve diversification out of dollar denominated securities. Conventional wisdom which holds that such diversification will have large effects on exchange rates and interest rates can be questioned on theoretical grounds and the empirical evidence is inconclusive.
• Likewise, the empirical evidence of significant effects of Asian reserve accumulation on interest rates on long term US government securities is not strong.
• An Asian Investment Corporation (AIC) that would pool a portion of Asia’s official reserves and manage them on commercial grounds as a national wealth fund could promote a better allocation of Asia’s accumulated savings.

Programme 2005 (pdf)

List of participants (pdf)