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Number 93-39, November 12, 1993

A Pacific Economic Bloc:

Is Theie Such an Animal?
In the last few years, efforts at forging regional
economic agreements to strengthen trade and
financial links among neighboring countries have
proliferated; two of the most familiar are the EC
(European Community) and NAFTA (North American Free Trade Agreement). By contrast, in East
Asia, now the fastest growing region in the world,
overt preferential trading arrangements or other
political moves to promote regional economic
integration are generally lacking. Still, there is
some speculation that East Asian countries have
responded to trade blocs in North America and
Europe by forming a de facto yen bloc. That is,
by some accounts, East Asian economies are increasingly pegging their exchange rates to the
yen (at the expense of the dollar) and building a
regional trading "bloc" that is centered on Japan.
This Weekly Letter uses statistical techniques to
examine whether such a yen bloc is forming. The
results provide little evidence either that the yen
is replacing the dollar as the dominant currency
in East Asian trade or that a de facto intra-Asian
trade bloc is emerging with Japan at its center.

Exchange rate targeting
Officially, only a few East Asian currencies are
pegged solely to the dollar; none is pegged officially to the yen. But, officially or de facto, many
link their currencies to a basket of major currencies. Typically, they do not announce the weights
they assign to various currencies or even the currency composition of their baskets; but the u.s.
dollar and Japanese yen are clearly on the list of
In spite of the secrecy, it is possible to infer their
policies by observing the actual behavior. That is,
if a yen bloc in East Asia were forming, one manifestation of it would be that the yen received
increasing weight in these countries' baskets. To
estimate the currency weights econometrically,
we ran regressions of the changes in the value of
the domestic currency against changes in the values of foreign currencies including the u.s. dollar
and the yen for nine countries-Korea, Taiwan,
Singapore, Hong Kong, Malaysia, Indonesia,

Thailand, the Philippines, and China. This analysis used weekly data (Friday close of the London
market) from the beginning of 1979 to the second
week of May 1992.
There were four main findings. (1) All nine currencies appear to assign a heavy weight to the
U.s. dollar. (2) Only one currency, the Singapore
dollar, has assigned significant weight to the yen
in addition to the dollar throughout the period.
(3) Certain currencies gave a bit of increased
weight to the yen during particular subperiods:
in 1981-1984 when the dollar was strongly appreciating (the Singapore dollar); in 1985-1986
as the dollar hit its peak and began to depreciate
(the Hong Kong dollar, Indonesian rupiah, Thai
baht); and in 1987-1988, after the dollar had
completed most of its depreciation (the New Taiwan dollar). (4) The only currencies to place a
significant weight on the yen in the most recent
subperiod (1991-1992), besides the Singapore
dollar, are the Malaysian ringgit and the Thai baht.
These findings indicate that the u.S. dollar remains the dominant currency in the exchange
rate policies of all East Asian economies. There is
no clear evidence that the yen is moving towards
replacing the U.S. dollar in the region.

The use of the dollar and yen in invoicing
Why have East Asian governments not sought to
link their currencies with the yen more strongly?
Although there is some evidence that the yen is
being used more widely as the invoicing currency for trade and related lending in Asia, the
share of the yen in the denomination of trade and
finance has not increased anywhere nearly as
rapidly as Japan's share of trade among the East
Asian countries. Developing and developed
countries alike have tended to invoice much of
their trade in U.S. dollars, rather than in their
own or their trading partners' currencies.
Why should the dollar rather than the yen be the
preferred invoicing currency in the Pacific region?
One possibility is that Japan itself resists the internationalization of the yen in order to avoid

large fluctuations of its reserves or to avoid destabilizing effects on its domestic price level.
Another possibility is that some of Japan's strategic trading partners (for example, oii-producing
countries) prefer to receive dollars from Japan
since they rely more on imports from the
This in turn may induce Japan to require the dollar as the invoicing currency even when trading
with East Asian countries. A third possibility is
a failure of international coordination. In other
words, the world might work equally (or even
more) efficiently if all countries were to replace
the dollar by the yen as an invoicing currency,
but no individual country would want to do this
on its own if other countries did not. Whatever
the reason, as long as the dollar remains the
dominant invoicing currency in international
trade and lending, it makes sense for the East
Asian economies to continue to assign a heavy
weight to the dollar.


Are there de facto trade blocs in the Pacific?
Even if there are few overt preferential trading
arrangements or other political moves to promote
regional economic integration in East Asia, there
are still concerns that de facto trade blocs are
emerging in this region. And some have hypothesized that Japan is indirectly forming an economic bloc through its flow of aid, foreign direct
investment, (1nd other forms of finance, to influence its trade with its neighbors.
To address the question of whether a yen bloc is
forming in East Asia, one must presumably ask
something more than whether the economies are
getting larger, or even whether economic flows
among them are increasing. One must ask whether
the share of intraregional trade is higher, or increasing more rapidly, than would be predicted
based on such standard economic factors as
GNP or the growth rates of the countries
For example, some who support the idea that a
de facto trade bloc exists in East Asia cite the fact
that the share of intraregional trade to its total
trade increased from 33 percent in 1980 to 37 percent in 1989. But these numbers are deceptive.
The Western Hemisphere and the EC also increased intragroup trade in the 1980s. In fact,
the EC, not Asia, has had both the highest and the
fastest increasing degree of intraregional trade,
reaching 59 percent in 1989.
Furthermore, if one allows for the phenomenon
that most of the East Asian countries in the 1980s

experienced rapid growth in total output and
trade, then it is possible that there has in fact
been no movement toward greater intraregional
bias in the evolving pattern of trade. The increase
in the intraregional share of trade could be entirely due to the increase in economic size of the
The "gravity model" provides a systematic
framework for measuring what amount of bilateral
trade is "normal" on the basis of geographical
distance between two countries, their economic
size, and other factors. If there were nothing to
the notion of regional trading blocs, then these
basic v(1riables would explain most of the bilateral trade, and there would be nothing left to
attribute to a dummy variable representing
whether two trading partners are both located
in the same region.
Our gravity regressions have produced two main
findings (see Frankel 1992, Frankel and Wei
1993(1, b). First, there is clear evidence of regional
trade bias. The intraregional trade dummies are
numerically large and statistically significant for
countries in East Asia and elsewhere in the world.
If two countries are both located in the Western
Hemisphere for example, they will trade with
each other by about 50 percent more than they
would otherwise, even after taking into account
proximity and the other gravity variables.
Second, however, there is no evidence of a trend

increase in the, intraregional bias of Asian trade
during the 1980s. In sharp contrast, the EC and
the Western Hemisphere showed rapid intensification of within-bloc trade in the course of the
1980s. Both show an approximate doubling of
their estimated intraregional bias coefficients.
We also consider a nested sequence of country
groupings as potential candidates for trading
blocs in the Pacific: ASEAN (Brunei, Indonesia,
Malaysia, the Philippines, Singapore, Thailand),
EAEC (proposed by Malaysia to consist of ASEAN
plus Hong Kong, Taiwan, Korea, China and
Japan), AP (a group we define as EAEC plus Australia and New Zealand), and APEC (AP plus the
u.S. and Canada). We investigate whether a
particular grouping of countries functions as an
independent trade bloc when a larger nesting
group is considered at the same time in the regression. APEC appears to be the correct place to
draw the boundary: Any bloc smaller than APEC,
such as ASEAN or EAEC, is not statistically significant when APEC is included in the same

regression. When we test for the broadest definition of a Pacific bloc, including Latin America, it
is not significant, and the other coefficients do
not change. It is interesting to note that the u.s.
and Canada belong to two distinct blocs simultaneously: APEC and the Western Hemisphere bloc.
What about bilateral trade between Asia-Pacific
countries and japan in particular? Our test indicates that there is no residual to be attributed to
japan's development of special trading relations
with other countries in its region, after one takes
into account distance, income, and level of development. Thus there is no evidence that Japan
has established or come to dominate a trading
bloc in Asia.

Western Hemisphere, is biased toward intraregional trade to a greater extent than can be
explained by distance, GNPs, and other gravity
variables. However, there is no evidence of any
trend increase in the intra-Asian trade bias; the
intra-Asian trade bias is not centered around
Japan, and the strongest "bloc" of any is a transPacific one that includes the U.S. and Canada
along with the East Asian countries.

Jeffrey Frankel
Shang-jin Wei
Assistant Professor,
Harvard University
University of California
at Berkeley
Visiting Scholar, FRBSF
Visiting Scholar, FRBSF

The analysis in this Weekly Letter fails to support
the notion that East Asian countries have formed
a yen bloc or a de facto trading bloc centered on
Japan. Instead we find that the
dollar continues to be the dominant international currency
in East Asian exchange rate policies. Some currencies did increase their weight on the yen
during the mid-1980s. But this may have been
motivated by a desire to <lvoid overvaluation of
their currencies in tandem with the dollar, instead of a genuine and steady increase in the
role of the yen. Only two or three currencies <lCtually showed a sign of increased yen weight at
the end of the sample. Overall, the evidence
does not suggest a substantial trend increase in
the role of the yen in East Asian exchange rate


Finally, the level of trade in East Asia, like trade
within the European Community and within the

Frankel, jeffrey. 1992. /lIs japan Creating a Yen Bloc in
East Asia and the Pacific?/I Forthcoming in Regionalism and Rivalry: japan and the U.S. in Pacific
Asia, eds. jeffrey Frankel and Miles Kahler. Chicago:
University of Chicago Press.
~~~~, and Shang-jin Wei. 1993a. /lYen Bloc or

Dollar Bloc? The Exchange Rate Policies of the East
Asian Economies./I Forthcoming in Macroecoc
nomic Linkages, eds. Takatoshi Ito and Anne
Krueger. Chicago: University of Chicago Press.
~~~~ and

. 1993b. /lTrade Blocs and
Currency Blocs./I NBER Working Paper No. 4335.

Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of
San Francisco, or of the Board of Governors of the Federal Reserve System.
Editorial comments may be addressed to the editor or to the author.•.• Free copies of Federal Reserve publications can be
obtained from the Public Information Department, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco 94120.
Phone (415) 974-2246, Fax (415) 974-3341.

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Index to Recent Issues of FRBSF Weekly Letter
















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Summer Special Edition: Touring the West
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California's Neighbors
Inflation, Interest Rates and Seasonality
Difficult Times for japanese Agencies and Branches
Regional Comparative Advantage
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The FRBSF Weekly Letter appears on an abbreviated schedule in june, july, August, and December.