Conclusion

This paper has considered the role that exchange rate changes can play in transpacific rebalancing. It first documented that PRC exports to the US were a major outlier in the global economy before the financial crisis that began in October 2008 and that imbalances between the PRC and the US have barely fallen since the crisis began. Evidence presented here indicates that an appreciation of the yuan relative to the dollar would be necessary to reduce these imbalances.

At the global level, however, a depreciation of the dollar may not rebalance America's trade. Multilateral trade elasticities reported here and also those reported by Chinn (2005a, 2005b) indicate that a depreciation of the dollar would not substantially reduce the aggregate US trade deficit. Thus, if the current account deficit remains a problem for the US going forward, absorption-reducing policies such as fiscal consolidation would probably be required.

This paper has also reviewed evidence concerning how exchange rates affect Asian exports and imports. The evidence indicates that: (i) sophisticated exports produced within regional production networks depend on exchange rates throughout the region; (ii) labor-intensive exports from developing Asian countries are strongly influenced by each country's own exchange rate; (iii) developing Asian countries compete extensively with each other in exports to third markets; (iv) an appreciation in developing Asia would increase capital and consumption goods imports; and (v) exchange rate volatility deters parts and components trade in Asia.

These findings imply that Asia and the rest of the world would benefit if East Asian currencies could appreciate together against external currencies while maintaining relative currency stability within the region. Since ordinary exports tend to be simple, labor-intensive goods while processed exports are sophisticated, capital-intensive goods, a generalized appreciation in East Asia would generate more expenditure-switching toward goods produced outside the region and contribute more to resolving global imbalances than an appreciation of the yuan or of other Asian currencies alone. In addition, exchange rate stability in Asia would facilitate the flow of parts and components and provide a stable backdrop for regional production and distribution networks. Further, it would prevent unpleasant outcomes such as beggar-thy-neighbor policies that arise because Asian economies not only cooperate within production networks but also compete in third markets.

One way for Asian countries involved in processing trade to appreciate together would be for the PRC to adopt a regime characterized by a multiple-currency, basket-based reference rate with a reasonably wide band. In this case, the huge surpluses generated within East Asian production networks would cause currencies in the region to appreciate together. Market forces could then allocate these appreciations across supply chain countries as a function of the size of their surpluses in processing trade.

Concerted appreciations in East Asia would give firms in the region an incentive to redirect production away from export markets toward domestic markets. This would not only lead to a more sustainable long-term equilibrium by reducing Asia's dependence on Western consumers but would also allow workers in the region to enjoy more of the fruits of their own labor.

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