1.5.3 Looking forward: implications and possible consequences
But what are the implications of these developments and trends? Clearly the emergence of a strong east-Asian bond market could threaten both the US dollar and the Euro markets, but this development is still in its infancy, and there are significant political and economic differences of interest amongst the possible east-Asian participants in such a market. So for the time being it will be the Euro and the US dollar that hold centre stage. But in as much as the Euro becomes a stronger currency, and the Euro-economy itself performs efficiently, there will be competitive pressures put upon the traditional dominance of the US dollar market. Given, also, that there are pressures to diversify away from dollar-denominated bonds, the USA may find itself facing difficulties in continuing to fund its balance of payments deficits. Whenever an ‘adjustment’ happens this could prove to be quick and painful for the USA.
This point is reinforced by the way in which exchange rate adjustment mechanisms are evolving in the emerging international two-currency world. While there was just a single ‘safe haven’ currency (the US dollar) which dominated the global trading system, in times of crisis or difficulty for countries or the system as a whole there was traditionally a ‘flight to quality or safety’, so funds would tend to move into the dollar. However, with a bi-polar currency world, where there are two possible ‘safe havens’, the system could become more unstable. Perhaps, paradoxically, the emergence of the Euro as a potential rival international currency could lead to greater instability in the international financial system rather than less. Currency movements are notoriously difficult to understand and predict – they tend not to follow economic fundamentals like growth rates, productivity, employment levels, or macroeconomic performance – but are dependent upon immediate events, confidence, reputation, expectations, rumour, and speculative possibilities. Under these circumstances, exchange rates between the US dollar and the Euro could tend to oscillate more widely and move more rapidly, hence destabilising the relationships between the two currencies and the international economy more generally. What becomes crucial under these conditions is the careful management of these relationships (Bromley, 2001). The evolution of the Euro exchange rate vis-à-vis the dollar and the yen is shown in Figure 3. This shows that the Euro depreciated against both currencies after its launch in 1999, but appreciated after 2001. The precise judgement of the magnitude of fluctuations will have to wait for a longer time span. But exchange rate management (involving coordination and intervention) goes against the grain and sentiment of economic policy making in this field. It is thought that complete flexibility in exchange rates, built upon market sentiment, must not be tampered with. While this analysis is not meant to imply an imminent dramatic destabilisation of the international financial system – the issues discussed above represent tendential features rather than actual trajectories – it poses the issue of the effective cooperation (if not coordination) between the authorities charged with ‘governing’ international economic relationships. It poses a challenge to the US and the EU authorities not to let this become too rivalrous and competitive, but for it to remain cooperative and consensual in character.