The emerging global dollar zone? A fleeting coincidence of events or a powerful new underlying force?

• Author: Zoakos, Criton M.

This fall, China was included in the G7 deliberations for the first time ever. This was the occasion in which the G7 endorsed China's monetary formula "to push ahead firmly and steadily to a market-based flexible exchange rate."

Among policymakers in Beijing and Shanghai, "market-based flexible exchange rate" does not mean appreciation of China's currency, the renminbi. It means: "If we liberalize the RMB on capital account, the ensuing capital flight would collapse the exchange rate of the RMB: therefore, we'll only liberalize on capital account--we'll move to 'a market-based flexible exchange rate'--when our domestic financial markets are reformed sufficiently to moderate capital outflows."

To which U.S. Secretary of the Treasury John Snow, and the G7 with him, responded: This is fine by us, but we'd like to see it done a bit more quickly. Or, in more formal language: "Sustained, non-inflationary growth in China is important for maintaining strong global growth, and a more flexible and market-based renminbi exchange rate is an important part of achieving this goal. I have been encouraged by some of the advances that have occurred. Tonight, I underscored that I would like to see China move more quickly."

It is therefore a done deal that exchange rate liberalization will occur when the domestic Chinese banking system has moved further along the lines of American "best practice" banking. It is not any specific level of exchange rate that has been negotiated. It is making the Chinese and American banking systems more compatible.

The formalities of a "dollar zone" are beginning to crystallize.

TWO YEARS IN THE MAKING

In the past two years, the economies of nine countries have been behaving as a quasi-integrated, de facto dollar currency zone. These are China, Hong Kong, Taiwan (these three together forming Greater China), Malaysia, Singapore, Thailand, Japan, South Korea, and of course the United States.

Their exchange rates are virtually unchanged since the beginning of 2002 (the yen and the won depreciated slightly against the dollar but all the others, and especially Greater China's, remained tightly pegged). Their domestic interest rates are at comparably similar low levels when adjusted for differences in local inflation rates. And their current account imbalances are being settled in the same way as between different districts of the U.S. Federal Reserve System--that is, by capital transfers from the surplus areas to the deficit areas...