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Before the 1997–98 crisis, the East Asian economies – except for Japan – informally pegged their currencies to the dollar. These soft pegs made them vulnerable to a depreciating yen, thereby aggravating the crisis. To limit future misalignments, the IMF wants East Asian currencies to float freely. Alternatively, authors have proposed increasing the weight of the yen in East Asian currency baskets. However, dollar pegs are entirely rational from the perspective of each Asian country – both to facilitate hedging by merchants and banks against exchange risk, and to help central banks anchor their domestic price levels. Post‐crisis, as the East Asian economies transform themselves from being dollar debtors into dollar creditors, they face ‘conflicted virtue’: pressure to appreciate their currencies that could lead to a deflationary spiral. Rather than undervaluing their currencies to promote exports as is commonly alleged, East Asian governments are trapped into returning to – and then maintaining – soft dollar pegs.

Abstract:Before the crisis of 1997-98, the East Asian economies-except for Japan but including China-pegged their currencies to the US dollar. To avoid further turmoil, the IMF now argues that these currencies should float more freely. However, our econometric estimations show that the dollar's predominant weight in East Asian currency baskets has returned to its pre-crisis levels. By 2002, the day-to-day volatility of each country's exchange rate against the dollar has again become negligible. In addition, most governments are rapidly accumulating a "war chest" of official dollar reserves, which portends that this exchange rate stabilization will come to extend over months or quarters. From the doctrine of "original sin" applied to emerging-market economies, we argue that this fear of floating is entirely rational from the perspective of each individual country. And their joint pegging to the dollar benefits the East Asian dollar bloc as a whole, although Japan remains an important outlier. F3, F31, F32, F331