At the time, East Asian countries were invoicing approximately 80% of their exports in U.S. dollars (USD), including intra-regional trade. To climb out of the crisis, some of these countries reduced the value of their currency – a policy known as devaluation – to make their exports more competitive in the global market; however, this policy only resulted in a dramatic decline in domestic demand. This worsened the crisis because trading partners faced export prices fixed in USD, while imports became relatively more expensive.
20 years later, certain established facts remain valid: two main channels expose small open economies to the value of the USD. First, the value of the USD impacts prices confronting all other countries in the global market, including those not trading directly with the United States. Second, the quantity traded annually decreased by approximately one-quarter of the corresponding increase in the value of the USD. As a consequence, the United States benefits from an "exorbitant privilege" in trade by limiting other countries in their scope of action thanks to spillover effects at play following the United States’ monetary policy affecting currency exchange rates.
In a world where economic sanctions are extensions of diverging political views, there has been a call to find ways to restrict this comparative advantage that benefits the United States at the expense of other players. It is indeed of primary importance to limit the use of economic tools to reinforce its political influence. In addition, the excessive power described above could act as a brake to the development of small open economies and therefore needs to be constrained.
Interestingly, however, is the ever-growing complexity of inter-country trade relations. When countries specialise in different stages along globalised production chains (the so-called Global Value Chains), this appears to offer an opportunity to limit the United States' hegemony in this specific context of USD dominance.
Evidence indeed suggests that the more a country is included in Global Value Chains, as defined by the share of foreign inputs in exports, the less it is exposed to the value of this currency.
Although the ever-growing complexity of inter-country trade relations offers fertile ground for a fierce battle for power, it also offers a potential opportunity for countries to optimally position themselves in Global Value Chains.
This article is part of “Student Works”, a news series highlighting the best student papers from the Graduate Institute.
Keywords: international economics