Shin-ichi Fukuda (University of Tokyo)** Masanori Ono

the role of vehicle currency as a unit account. Assuming that the exporter commits to sell the demanded quantity at the ex post realized price, they e...

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On the Determinants of Exporters’ Currency Pricing: History vs. Expectations * Shin-ichi Fukuda (University of Tokyo)** Masanori Ono (Fukushima University)

January 14, 2006

Abstract The purpose of this paper is to investigate why the choice of invoice currency under exchange rate uncertainty depends not only on expectations but also on history. The analysis is motivated by the fact that the U.S. dollar has historically been the dominant vehicle currency in developing countries. The theoretical analysis is based on an open economy model of monopolistic competition. When the market is competitive enough, the exporting firms tend to set their prices not to deviate from those of the competitors. As a result, a coordination failure can lead the third currency to be a less efficient equilibrium invoice currency. The role of expectations is important in selecting the equilibrium in the static framework. However, in the dynamic model with staggered price-setting, the role of history becomes another key determinant of the equilibrium currency pricing. The role of history may dominate the role of expectations when the firms are myopic, particularly in the competitive local market. It also becomes dominant in the staggered price setting when a small fraction of the new price setters are backward-looking. The result suggests the importance of history in explaining why the firm tends to choose the US dollar as vehicle currency.

Key Words: invoice currency, export price, monopolistic competition, staggered price JEL classification number: F12, F31, F33

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An earlier version of this paper was presented at the TRIO conference in Tokyo. We would like to thank A. Rose, K. Sato, and other participants of the conference for their helpful comments. Fukuda’s research is supported by Japanese Government, Ministry of Education Aid for Science Research on Priority Area #12124203. ** Correspondence to: Shin-ichi Fukuda, Faculty of Economics, University of Tokyo, 7-3-1 Hongo Bunkyo-ku Tokyo 113-0033 Japan, Phone: 81-3-5841-5504, Fax: 81-3-5841-5521, e-mail: [email protected]

1. Introduction

The purpose of this paper is to investigate the choice of invoice currency in developing countries. In previous literature, several theoretical studies investigated the choice of invoice currency in international trade. Baron (1976) and Giovannini (1988) are their early attempts. The authors such as Bacchetta and van Wincoop (2002), Devereux and Engel (2001), and Devereux, Engel, and Storegaard (2004) use a general equilibrium setup. Recent studies that investigate pricing behavior of international trade with developing countries include Frankel, Parsley and Wei (2004). Most of previous studies analyzed the case where the exporting firm sets prices

either in the exporters’ currency (producer’s currency pricing, PCP) or in the importers’ currency (local currency pricing, LCP). It is, however, well known that some of international trades are invoiced in a third currency, that is, vehicle currency (vehicle currency pricing, VCP). Over most of the past hundred years, first the pound sterling and then the U.S. dollar have played a special role as vehicle currency in international trade.1 Except for primary commodities, the role of vehicle currency is relatively limited in international trade among developed countries (see McKinnon [1979] and Magee and Rao [1980]).2 The U.S. dollar, however, has historically been the dominant vehicle currency in international trade with developing countries. Many developing countries have chosen the U.S. dollar as the vehicle currency even when they have the other developed countries as important trade partners. The choice of invoice currency is particularly important in developing countries where efficient forward markets as well as other foreign exchange derivatives are missing to hedge the exchange rate risk. The following theoretical analysis is based on an open economy model of monopolistic competition. Since the export prices are set in advance, the exporting firms face uncertainty of exchange rates. If necessary, the exporting firm set prices in its own currency or in the currency of the importing country. However, when the market is competitive enough, the exporting firms tend to set prices not to deviate from those of the competitors. As a result, when the other exporters are expected to set their prices in the third currency, the exporting firms tends to invoice in the third currency. The tendency becomes conspicuous in the staggered price-setting framework where history becomes a key determinant of the invoice currency. 1

Historians estimate that 60% to 90% of the world’s trade was invoiced in the pound sterling in the 19th century. See, for example, Broz (1997). The pound sterling retained its dominant position as key currency in the interwar period, although the UK passed from net creditor to net debtor after World War I. 2 There are numerous empirical studies that explore the choice of invoice currency. Some of recent studies include Donnenfeld and Haug (2003) for Canadian experience, Fukuda and Ono (2005) for

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Our model follows a partial equilibrium model in Bacchetta and van Wincoop (2002). It, however, has three distinctive features that the previous study did not have. First, we allow the exporting firms to choose the third currency as an invoice currency. In developing countries, the exporting firms are under competition because of less differentiated products. It is thus a natural choice for the exporting firm to set prices in the third currency when the competitors are expected to set their prices in the third currency. The result explains the role of the US dollar as vehicle currency that prevails in many developing countries. Second, we consider a dynamic Nash equilibrium where players move sequentially. The model is in the tradition of Taylor (1980, 2000), in that price-setting is staggered.3 Firms that adjust their price in a given period set their price to maximize the present discounted value of profits over the periods that the price will be charged. Even in the dynamic Nash equilibrium, the expectations determine the equilibrium currency pricing when the discount rate is negligible. However, history becomes the key determinant of the equilibrium currency pricing when future profits are discounted, particularly in the competitive local market. Third, we show that a coordination failure can lead the third currency to be an equilibrium invoice currency. Since multiple equilibria are Pareto ranked, it implies that the equilibrium choice of the invoice currency may lead to a less efficient equilibrium. The risk averse exporters are always better off under the exporters’ currency pricing than under any other currency pricing. It would be more efficient for the exporters to change their invoice currency from the vehicle currency to their own currency. To improve the welfare, changing their expectations is an important factor. However, when history does matter, it is difficult to change the expectations without reducing the discount rate or increasing their competitiveness. In previous literature, some studies explored the role of vehicle currency in international trade. Krugman (1980) and Rey (2001) show that transaction costs might make vehicle currency a dominant medium of exchange in international trade. These studies are, however, successful only in explaining the role of vehicle currency as a medium of exchange, through which transactions between currencies are made. In contrast, our approach tries to explain the role of vehicle currency as a unit account in terms of which prices of commodities are set. A unit account is another important function of vehicle currency. Friberg (1998) and Goldberg and Tille (2005) are two exceptional studies that investigated the role of vehicle currency as a unit account. Assuming that the exporter commits to sell the demanded quantity at the ex post realized price, they explored under what conditions the monopolistically competitive exporter chooses the third currency as vehicle currency. None of these studies, however, explored the case where a coordination failure can lead to less efficient equilibrium under vehicle currency pricing. More importantly, these studies are static analysis that could not analyze the case where “history” does matter. It is well known that the U.S. dollar has historically Korean experience, Fukuda and Ji (1994), Oi, Otani, and Shirota (2004) for Japanese experience, and Wilander (2004) for Swedish experience. 3 For recent contribution, see Chari, Kehoe, and McGrattan (2000).

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been the dominant vehicle currency in most of developing countries. The following model will show that “history” is a key determinant for the exporters’ pricing behavior in developing countries. The paper proceeds as follows. After providing some empirical evidence on the invoice currency in section 2, section 3 describes our basic model structure. Section 4 drives its Nash equilibria in the static framework. Section 5 explores the dynamic model with the staggered price setting and shows that history does matter on the choice of invoice currency. Section 6 extends the model to the case where some of the new price setters change the expectations as leaders. Section 7 summarizes our results and refers to their implications.

2. Some Empirical Evidence During the past decades, the U.S. dollar has been the dominant vehicle currency in international trade with developing countries. The Bank of Thailand reports various data sets that support this view. Table 1 shows in which currencies Thai exports have been invoiced since 1993. It states that nearly 90% of Thai exports have been invoiced in the US dollar and that only 10% have been invoiced in the Japanese yen. The percentages are almost stable throughout the period, although the ratios of the U.S. dollar show marginal declines after 1998. The view is more strongly supported by Table 2 that reports the invoiced ratios of Thai exports classified by major trade partners. The table indicates that the U.S. dollar tends to be the dominant vehicle currency in Thai exports to various countries. When the United States, Canada, or Mexico are trade partners, almost all of the exports are invoiced in the US dollar. Even when Japan, Europe, or the other East Asian countries are trade partners, majority of the exports are invoiced in the US dollar. For example, in the exports to Japan, more than 70% are invoiced in the US dollar and only 20% are invoiced in the Japanese yen. The invoiced ratio in the U.S. dollar is relatively modest in the exports to Germany. However, most of exports are invoiced in the US dollar in the exports to the other European countries, particularly to Denmark, France, Ireland, United Kingdom, and Finland. The dominance of the US dollar also prevails in the exports to other East Asian countries.4 In particular, in the exports to Singapore, Malaysia, and Vietnam, more than 90% are invoiced in the US dollar. Except for the exports to the United States, the US dollar is a third currency in the Thai exports. This implies that the U.S. dollar tends to be chosen as the dominant vehicle currency in invoicing most of Thai exports.

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Exceptions are the exports to Cambodia, Laos, and Myanmar. In the exports, Thai Baht is equally important invoice currency. This is probably because the Thai economy has a strong influence to these countries.

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The result is essentially the same for the invoiced currency ratios in Korean exports. Table 3 reports in which currencies Korean exports have been invoiced since 1976. It shows that the invoiced ratios of the US dollar were over 90% in visible exports and over 80% in invisible exports. The dominant ratios of the US dollar declined during a past decade years. However, even in recent years, the ratios of the US dollar still lied between 85% and 90% in Korean visible exports and around 75% in Korean invisible trades. Table 4 summarizes the amount shares of various export destinations from Korea and Thailand. We can see that Japan and Western Europe as well as other Asian countries have been the other important trade partners for Thai and Korean exports. The evidence indicates that the U.S. dollar was chosen as the dominant vehicle currency even in the case where the United States is not a dominant trade partner. It is noteworthy that Japan has been the second biggest partner for both Thai exports

and Korean exports. This implies that Thai and Korean exporters choose the U.S. dollar as the vehicle currency even in the exports to one of the most important trade partners. One may argue that these countries choose the U.S. dollar as the dominant invoice currency because their exchange rates are stable against the U.S. dollar. The argument may have been relevant before the Asian crisis when they effectively pegged their currencies to the U.S. dollar (see, for example, Frankel and Wei [1994]). However, after the crisis, these countries shifted the exchange rate regime from de facto dollar peg to float. As a result, there is no longer a natural reason for them to choose the U.S. dollar as the dominant invoice currency to stabilize their export prices in terms of domestic currencies. One may also argue that the U.S. dollar is the dominant invoice currency because trading companies are in charge of both exports and imports at the same time. When the amount of exports is equal to the amount of imports, the exchange rate risk can be perfectly diversified. Therefore, if trading companies invoice both exports and imports in the US dollar, they would make a partial diversification of exchange rate risk. Table 5 reports components of Thai export receipts in 2001 and 2002. It shows that about 30% of export receipts are deposited to foreign currencies in both years. The percentages indicate that Thai exporters may keep some of their foreign exchange receipts for reducing exchange risk in future import payments. The table, however, also reports that about 65% of export receipts are exchanged from foreign currencies to Thai Baht directly. This implies that more than two thirds of export receipts are still exposed to exchange risk in Thailand.

3. A Model of Export Pricing Behavior under Exchange Rate Uncertainty

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The purpose of the following sections is to present our theoretical framework that discusses pricing behavior under exchange rate uncertainty. The pricing behavior we study in the following analysis is that of exporters who produce only in their home country. For simplicity, we assume that all exporting firms sell all of their products in a single foreign market. There are three countries: an exporting country, an importing country, and a third country. The third country has no international trade with the other two countries. Each exporter sets its export price before the exchange rates are known. In setting the export price, it has the choice among its own currency pricing (i.e., producer’s currency pricing, PCP), the importers’ currency pricing (i.e., local currency pricing, LCP), and the third currency pricing (i.e., vehicle currency pricing, VCP). The exchange rates s0, s, and s/s0 are exogenous and are assumed to be the only source of uncertainty. Selling s0 units of the third currency leads to one unit of the importers’ currency on the spot market and selling s units of the exporters’ currency leads to one unit of the importers’ currency on the spot market. By definition, the exchange rate between the exporters’ currency and the third currency is given by the relation s/s0. For simplicity, we assume that each exchange rate is independently identically distributed with constant mean over time. We also assume that s is uncorrelated with s0, so that E (s - E s)(s0 - E s0) = 0. In the following analysis, each exporter is under monopolistic competition and firm j faces the demand function D(pj, P*), where pj is the price set by the firm j measured in the importers’ currency. P* is the aggregate price index in the importers’ local market denominated in the importers’ currency. The aggregate price index P* depends on the exchange rate unless all exporting firms set their prices in the importers’ currency. We assume that the total number of firms is large enough so that an individual firm does not affect the price index P*. The objective of each exporter is to maximize the expected profits in terms of his (or her) home currency. The central assumptions are that the exporter has to set price before the exchange rates are known and that demand is a function of the price that importers face after exchange rate uncertainty is resolved. Suppose that each exporter chooses pE under the exporters’ currency pricing, pI under the importers’ currency pricing, and p0 under the third currency pricing. By definition, the unit price of imports in terms of the importers’ currency is pE/s when invoiced in the exporters’ currency, pI when invoiced in the importers’ currency, and p0/s0 when invoiced in the third currency. Let ΠE, ΠI, and Π0 denote the exporter’s profit under the exporters’ currency pricing, under the importers’ currency pricing, and under the third currency pricing respectively. The profit from each currency pricing is then respectively given by (1) ΠE = pE D(pE/s, P*) – C[D(pE/s, P*)], (2) ΠI = s pI D(pI, P*) – C[D(pI, P*)],

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(3) Π0 = (s/s0) p0 D(p0/s0, P*) – C[D(p0/s0, P*)],

where C[·] is cost function that is strictly increasing and strictly convex. The costs are assumed to be incurred in terms of the exporters’ currency. In the following analysis, we assume that the firms are risk averse and maximize the expected utility from the profits. The utility function of each firm is U (Π), which is strictly increasing and strictly concave in Π.

4. The Static Analysis (i) The model structure We first consider the static case where the price is fixed only for a period. In equilibrium, each exporter chooses the exporters’ currency pricing if EU(ΠE) ≥ EU (ΠI) and EU (ΠE) ≥ EU (Πo), the importers’ currency pricing if EU (ΠI )≥ EU (ΠE) and EU (ΠI) ≥ EU (Π o), and the third currency pricing if EU (Π0) ≥ EU (ΠI )and EU (Πo) ≥ EU (Π E). For analytical simplicity, we assume the following set of constant elasticity demand and cost functions:

(4)

D(pj, P*) = A (pj/P*)-µ,

(5)

C(D) = B Dη,

where µ > 1 and η > 1. If the consumers in the importing country have CES preferences with elasticity µ > 1 among the different products, we can specify the demand for goods from firm j as (4). Larger µ implies higher (smaller) degree of substitutability among the products. The aggregate price index in the importers’ local market P* is given by

⎛1 (6) P* = ⎜ ⎝N

N

∑p i =1

1− µ i

⎞ ⎟ ⎠

1 /(1− µ )

where N is the number of firms in the importers’ local market and pi is a price set by exporting firm i in the importers’ currency. Under (4) and (5), the representative exporter’s expected utility for each currency denomination is respectively written as (7) E U(ΠE) = E U {A pE [(pE/s) / P*)]-µ – AηB [(pE/s) / P*)]-µη},

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(8) E U(ΠI ) = E U {A s pI (pI /P*)-µ – AηB (pI /P*)-µη}, (9) E U(Π0 ) = E U {A (s/s0) p0 [(p0/s0) / P*)]-µ – AηB [(p0/s0) / P*)]-µη}. Since the choice of currency pricing is irrelevant under certainty, it holds that ΠE = ΠI = Π0 ≡ Π* near s0 = E s0 and s = E s. We can also show that pE = pI E s = p0 (E s /E s0) = Aη-1B µη/(µ-1). It is easy to see that the optimal price is a constant markup µ/(µ-1) over the marginal cost B. By using the envelop theorem, a second order Taylor expansion near s0 = E s0 and s = E s leads to (10) E U (Πj) ≈ U(Π*) + (1/2) U′(Π*) (Π11j σ02 + Π22j σ2), for j = E, I, and 0, where Π11j ≡ d2Πj/d s02 and Π22j ≡ d2Πj/d s2 at s0 = E s0 and s = E s. After some tedious calculations shown in Appendix, we therefore obtain that near s0 = E s0 and s = E s, (11) [E U(Π0) - E U (ΠI)]/ U′(Π*) = (1/2) [∂2Π0/∂ s02 + 2 (∂2Π0/∂ P*∂ s0)(∂P*/∂ s0)] σ02, = - {(1/2) (1/s0) 2 [µ(η-1) + 1] + (1/p0)(η-1)µ (∂P*/∂ s0)} pE A (µ-1)σ02, (12) [E U(Π0)- E U (ΠE) ]/ U′(Π*) = (1/2) {[∂2Π0/∂ s02 + 2 (∂2Π0/∂ P*∂ s0)(∂P*/∂ s0)] σ02 - (1/2){∂2ΠE/∂ s2 + 2[(∂2ΠE/∂ P*∂ s) - (∂2ΠI/∂ P*∂ s)](∂P*/∂ s)} σ2, = - {(1/2) (1/s0) 2 [µ(η-1) + 1] + (1/p0)(η-1)µ (∂P*/∂ s0)} pE A (µ-1)σ02 + {(1/2) (1/s) 2 pE [µ(η-1) - 1] + (η-1)µ (∂P*/∂ s)} A (µ-1) σ2, (13) [E U (ΠI) - E U(ΠE)]/ U′(Π*) = - (1/2){∂2ΠE/∂ s2 + 2[(∂2ΠE/∂ P*∂ s) - (∂2ΠI/∂ P*∂ s)](∂P*/∂ s)}σ2, = {(1/2) (1/s) 2 pE [µ(η-1) - 1] + (η-1)µ (∂P*/∂ s)} A (µ-1) σ2. where we denote the variances as σ2 ≡ E (s - E s)2 and σ02 ≡ E (s0 - E s0)2 respectively.

(ii) Nash equilibrium Based on (11)-(13), we investigate which currency the exporters denominate their product in a Nash equilibrium. Focusing on a symmetric equilibrium, we can show that both the importers’ currency pricing and the third currency pricing are a Nash equilibrium under the same condition, that is, if (14) µ(η-1) > 1.

This is because there is a herding effect where the exporting firms keep their prices not to deviate from those of the competitors under the competitive market. When the importers’ currency pricing is

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a Nash equilibrium, it holds that P* = pI, so that equation (11) is always negative. Therefore, the importers’ currency pricing is a Nash equilibrium only if equation (13) is positive, that is, µ(η-1) > 1. When the third currency pricing is a Nash equilibrium, it holds that P* = p0/s0. Since ∂ P*/∂ s0 = p0/s02 when P* = p0/s0, equation (12) is always positive if equation (11) is positive. Therefore, the third currency pricing is a Nash equilibrium only if equation (11) is positive, that is, µ(η-1) > 1. In contrast, the exporters’ currency pricing is a Nash equilibrium under more general environments. When the exporters’ currency pricing is a Nash equilibrium, it holds that P* = pE/s. Since ∂ P*/∂ s = - pE/s2 when P* = pE/s, both equations (12) and (13) are negative if (15) µ(η-1) + 1 ≥ 0,

The exporters’ currency pricing is therefore a Nash equilibrium if (15) holds. The exporters’ currency pricing is the only Nash equilibrium if µ(η-1) < 1. The denomination in the exporters’ currency tends to be a Nash equilibrium when the local market is less competitive. However, it is noteworthy that the model has multiple Nash equilibria where any currency pricing is an equilibrium if both (14) holds. Under the multiple Nash equilibria, the choice of the currency denomination becomes arbitrary depending on the exporters’ expectations on which currency the other exporters will choose (that is, sunspots do matter). In our model, the multiple Nash equilibria occur when µ is large, that is, when the market is competitive. In the competitive market, the exporter looses its market shares when its price exceeds the competitors’. It is therefore important for the exporting firms to choose the same currency pricing as that of the competitors. This indicates that the exporters’ expectations lead to arbitrary price setting, especially when the exporters face a competitive local market. It is worthwhile to note that multiple equilibria are Pareto ranked. This implies that the equilibrium choice of invoice currency may be a less efficient equilibrium. The expected utility of each exporter in the Nash equilibrium is respectively written as (16a) EU(ΠI) = E U (A s pI – AηB) under the importers’ currency pricing, (16b) EU(Π0) = E U [A (s/s0) p0 – AηB] under the third currency pricing, (16c) EU(ΠE) = E U (A pE – AηB) under the exporters’ currency pricing. Since U(ΠE) = U(ΠI ) = U(Π0) ≡ U(Π*) near s0 = E s0 and s = E s, the risk averse exporters are always better off under the exporters’ currency pricing than under any other currency pricing. The exporters’ utility is higher (lower) under the importers’ currency pricing than the third currency

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pricing when the variance of s is smaller (larger) than the variance of s/s0. In our model, a coordination failure may make the equilibrium choice of invoice currency less efficient.5

5. The Dynamic Analysis (i) The model framework In the last section, we explored the choice of currency pricing in the static framework. The framework is useful when considering under what circumstances expectations determine the choice of invoice currency in competitive local markets. However, since the expectations are not pathdependent, the static framework cannot explain why history is another key factor in determining equilibrium currency pricing. It is widely observed that the US dollar has historically been the dominant invoice currency in many developing countries. We need a theory that explains why history does matter in determining equilibrium currency pricing. In this section, we consider a dynamic Nash equilibrium where players move sequentially. As in the previous section, each exporter sets price before the exchange rates are known and the demand is a function of the price that importers face after exchange rate uncertainty is resolved. However, the price contract is long-term so that the exporters cannot change the prices for period H. The model is in the tradition of Taylor (1980, 2000), in that price-setting is staggered: each firm sets its price for H periods.6 In each period, a fraction 1/H of firms can choose their new price but a fraction 1-1/H of firms cannot. Firms that adjust their price in a given period set their price to maximize the present discounted value of profits over the H periods that the price will be charged. Define the present discounted value of profits as Vt E ≡ ∑ tH=1 β t −1EU (Π tE ) under the exporters’ currency pricing, as Vt I ≡ ∑tH=1 β t −1 EU (Π tI ) under the importers’ currency pricing, and as Vt 0 ≡ ∑ tH=1 β t −1EU (Π t0 ) under the third currency pricing respectively, where β is a discount factor. In equilibrium, each exporter chooses the exporters’ currency pricing if Vt E ≥ Vt I and Vt E ≥ Vt 0, the importers’ currency pricing if Vt I ≥ Vt E and Vt I ≥ Vt 0, and the third currency pricing if Vt 0 ≥ Vt I and Vt 0

≥ Vt E. Unlike the static model, the dynamic model requires the comparison of the present discounted

value of profits over H periods.

Under symmetric Nash equilibrium, all export prices are equalized, so that D(pj, P*) = A (pj/P*)-µ = A. The welfare of consumers in the importing countries therefore does not depend on the choice of invoice currency. 6 It has been more common in recent work with sticky-price models to use the Calvo framework, in which firms face an exogenous, constant probability of being able to adjust their price. The following results essentially hold even in the Calvo framework. 5

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If all exporters set the prices simultaneously, the dynamic analysis degenerates into the static case discussed in the last section. In this case, to the extent that the condition (14) holds, only expectations matter in determining equilibrium currency pricing even in the dynamic framework. However, if there is heterogeneity in the price settings, the currency the exporters initially chose could continue to be the equilibrium denomination currency as inertia. The staggered price setting is a useful assumption that incorporates heterogeneity in the price settings in the dynamic framework. When the equilibrium currency pricing is history dependent and is chosen as inertia, the role of expectations disappears in the dynamic Nash equilibrium because changed expectations are not selffulfilling. To see this, suppose that all of the exporters had historically fixed their prices in the third currency until period 0. Suppose also that at period 1, the new price setting exporters formed new expectations that all of the new price setters would fix their prices in the exporters’ currency after period 1. If the new expectations are self-fulfilling, switching from the third currency pricing to the extorters’ currency pricing at period 1 would be a Nash equilibrium. Otherwise, the third currency pricing would remain the Nash equilibrium even after period 1. When the expectations are self-fulfilling, it is likely to hold that EU (Πt E) < EU (Πt o) for t < T and that EU (Πt E) > EU (Πt o) for t ≥ T, where 1 < T < H. This is because the third currency pricing is still dominant among the exporters when t is small but the exporters’ currency pricing becomes dominant when t is large. To fulfill the expectations that all of the new price setters would fix their prices in the exporters’ currency after period 1, it is thus necessary that (17) ∑ tH= T β t −1 ⎡ EU (Π tE ) − EU (Π t0 )⎤ ≥ ∑Tt=−11 β t −1 ⎡ EU (Π t0 ) − EU (Π tE )⎤ . ⎢⎣ ⎥⎦ ⎢⎣ ⎥⎦

The above condition is a necessary condition for the exporters’ currency pricing to be a new Nash equilibrium. If the condition (17) does not hold, the third currency would remain the equilibrium denomination currency as inertia.7

(ii) Calibration To understand what makes the condition (17) less likely to hold and under what conditions the third currency remains to be the Nash equilibrium, we specify the utility function and calculate the expected utility of the profit under three alternative currency pricings. We specified the utility function of the exporters as U (Π ) ≡

Π /2 and calculated the utilities of the exporters for 10,000 random samples

of exchange rates, assuming that the changes of the exchange rates follow standard normal distribution

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with zero mean.8 In the calibration, we choose the parameter set such that η = 3, A = 1, and B = 10. We also set that H = 48. In our model, a fraction of 1/H of all exporters set prices each period for H periods. The period H always corresponds to the period for prices are sticky (e.g., one year), so that the large value of H implies the large degree of staggering. What is important in the following calibration is that the value of H needs to be large enough for the price setters to be very heterogeneous.9 Figures 1-a, 1-b, and 1-c draw the calibrated values of EU (Πt E), EU (Πt o), and EU (Πt I) from t = 1 to t = H for three alternative values of µ: µ = 5, 7.5, and 10. The calibrated values are based on the assumption that all of the exporters had fixed their prices in the third currency until period 0 but that all of the new price setters would fix their prices in the exporters’ currency after period 1. Regardless of the choice of µ, EU (Πt o) exceeds both EU (Πt E) and EU (Πt I) when t < 24, while EU (Πt E) exceeds both EU (Πt o) and EU (Πt I) when t ≥ 24. This reflect the fact that the third currency pricing is still dominant among the exporters when t is small but the exporters’ currency pricing becomes dominant when t is large. Analytically, the overall price index at period t (t = 1, 2, …, H) is

t ⎡ t ⎤ (18) Pt = ⎢( )( p E / s )1− µ + (1 − )( p 0 / s 0 )1− µ ⎥ H ⎣ H ⎦ *

1 /(1− µ )

.

Even after period 1, a fraction 1 - t/H of firms still keep denominating the price in the third currency at period t (t = 1, 2, …, H) in the staggered price setting. The weight of firms that keep denominating the price in the third currency is large when t is small but declines over time. The weight of firms that denominates the price in the exporters’ currency becomes large when t is large. The calibrated utilities in the figures reflect these environments. When the discount factor β is small (that is, when the exporters are myopic and discount the future profits enough), the losses from changing expectations always dominate the benefits in the future. It is therefore costly to change the denomination currency, so that the exporters’ currency pricing will not be a new Nash equilibrium. For example, when β = 0.98, Vt 0 = 298.69, Vt E = 298.32, and VtI = 298.52 when µ = 10; Vt 0 = 307.34, Vt E = 307.18, and VtI = 307.27 when µ = 7.5; Vt 0 = 325.27, Vt E = 325.23, and VtI = 325.25 when µ = 5. The condition (17) does not hold for any of the three alternative 7

Strictly speaking, for the third currency to remain the equilibrium currency, we also need that switching from the third currency pricing to the importers’ currency pricing at period 1 would not be a Nash equilibrium. 8 In the calibrations, we also tried varieties of normal distributions with different variances. The essential results were, however, the same.

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values of µ. Since the exporters have no incentive to change its denomination currency from the third currency to the exporters’ currency, they continue the third currency pricing as inertia when the future profits are discounted enough. In contrast, when β is very close to one, the changed expectations can lead the exporters’ currency pricing to be a new Nash equilibrium. When β = 1, Vt 0 = 461.36, Vt E = 461.79, and VtI = 461.60 when µ = 10; Vt 0 = 474.98, Vt E = 475.27, and VtI = 475.13 when µ = 7.5; Vt 0 = 502.85, Vt E = 503.02, and VtI = 502.94 when µ = 5. In our parameter set, Vt E always exceeds both Vt 0 and VtI under the changed expectations for any of the three alternative values of µ. The exporters have an incentive to change its denomination currency from the third currency to the exporters’ currency when the exporters do not discount the future profits. Only expectations play the essential role in changing the equilibrium currency pricing. To the extent that all of the new price setters are expected to fix their prices in the exporters’ currency after period 1, the exporters’ currency pricing always becomes a new Nash equilibrium after period 1 when β = 1. It is, however, worthwhile to note that the exporters need to change the expectations after period 1 for the exporters’ currency pricing to be an equilibrium. If none of the new price setters changed the expectations at period 1, the third currency pricing would remain a Nash equilibrium after period 1 even when β = 1. In our parameter set, some intermediate cases arise when β is around 0.99. When β = 0.99, Vt 0 = 368.06, Vt E = 368.00, and VtI = 368.05 when µ = 10; Vt 0 = 378.82, Vt E = 378.84, and VtI = 378.84 when µ = 7.5; Vt 0 = 400.98, Vt E = 401.02, and VtI = 401.01 when µ = 5. The exporters have an incentive to change its denomination currency from the third currency to the exporters’ currency if µ = 5 or 7.5 but do not if µ = 10. When β = 0.9875, Vt 0 = 348.77, Vt E = 348.62, and VtI = 348.72 when µ = 10; Vt 0 = 358.95, Vt E = 358.91, and VtI = 358.94 when µ = 7.5; Vt 0 = 379.93, Vt E = 379.95, and VtI = 379.94 when µ = 5. The exporters have an incentive to change its denomination currency from the third currency to the exporters’ currency if µ = 5 but do not if µ = 10 or 7.5. Note that the parameter µ becomes large when the importers’ local market is competitive. Because of less differentiated products, competitive local market is more relevant for exporters in developing countries. It is therefore more likely that the exporters continue the third currency pricing as inertia in developing countries. As in the static model, the risk averse exporters are always better off under the exporters’ currency pricing than under any other currency pricing in the long-run. Therefore, even in the dynamic Nash equilibrium model, a coordination failure may make the equilibrium currency pricing less efficient. However, unlike in the static model, not only expectations but also history plays a key role in 9

Altering the interpretation of the time unit, we can vary H to examine its role in affecting equilibrium currency pricing. For example, if the time unit is semi-monthly or weekly, we can set the value of H reasonably large.

12

determining the equilibrium currency pricing. The exporters know that moving from the third currency pricing to the exporters’ currency pricing is desirable in the long-run. However, they also know that majority of the other exporters cannot change the past currency pricing rule in the short-run. History therefore discourages their incentive to change the currency pricing role. The role of history becomes particularly important when the price settings are very heterogeneous, when the future profits are discounted, and when the local market is competitive. In most developing countries, the US dollar has historically been the dominant vehicle currency. This has been true even when the other developed countries are another trade partners for the developing countries. Once a country’s currency is established as an invoice currency, a large change in economic environment is necessary to replace it, even if the relative economic power of that country has declined in world trade. In the long-run, it would be more efficient for the exporters to change their invoice currency from the vehicle currency to their own currency. To achieve the longrun goal, changing their expectations is an important factor. However, when history does matter, making the firms less myopic and increasing their competitiveness would be the other important factors to improve their welfare.

6. The Model with Backward-looking Price Setters In the last section, we investigated a dynamic Nash equilibrium where all of the new price setters change the expectations simultaneously. However, given that all of the exporters had fixed their prices in the third currency until period 0, it is less likely that all of the new price setters would suddenly change their expectations on currency pricing after period 1. Instead, it is more likely that some of the new price setters form backward-looking expectations at period 1. Only forward-looking leaders would change the expectations at period 1 and that the other new price setters would follow the leaders after period 2. The purpose of this section is to investigate a dynamic equilibrium under such expectation formation with inertia. As in the last section, all of the exporters had fixed their prices in the third currency until period 0. However, unlike in the last section, we assume that a fraction α of the new price setters (0 < α < 1) observed a sunspot at the beginning of period 1. Only those who observed the sunspot fix their prices in the exporters’ currency at period 1 and form new expectations that all of the new price setters would follow the currency pricing after period 2. If the new expectations are self-fulfilling, switching from the third currency pricing to the extorters’ currency pricing at period 1 would be a new equilibrium. Otherwise, the third currency pricing would remain the only equilibrium even after period 1. When the fraction α is large enough, it still holds that EU (Πt E) < EU (Πt o) for t < T* and that EU (Πt E) > EU (Πt o) for t ≥ T*, where 1 < T* < H. However, T* becomes larger as α become

13

smaller. This is because a fraction α of the exporters, who had chosen the third currency pricing at period 1, cannot change their currency pricing until period H+1. As in the last section, we specify the utility function of the exporters as U (Π ) ≡

Π /2 and choose

the parameter set such that η = 3, µ = 7.5, A = 1, and B = 10 in the calibration. Unlike in the last section, we set that H = 5 (so that the unit of time is monthly or quarterly). The use of the lower value of H is to demonstrate whether history matters or not even if the price setters are less heterogeneous. Without backward-looking price setters (that is, when α = 1), the new expectations would be self-fulfilling unless β is unreasonably small. However, when α is less than 1, the new expectations may not be self-fulfilling even if β is close to one. We calculated the utilities of the exporters for 10,000 random samples of exchange rates, assuming that the changes of the exchange rates follow standard normal distribution with zero mean. Table 6 reports the calibrated values of Vt E, Vt I, and Vt 0 for alternative values of α and β. When α = 1, Vt E exceeds both Vt I and Vt 0 if β is greater than 0.71. When α = 0.9, Vt E still exceeds both Vt I and Vt 0 if β is greater than 0.82. This implies that the expectations are self-fulfilling under reasonable discount rates if most of the new price setters observe the sunspot at the beginning of period 1. In contrast, when α = 0.75, neither Vt E nor Vt I exceeds Vt 0 even if β = 1. This implies that more than three-fourth of the new price setters need to be forward-looking leaders at period 1 for the exporters’ currency to be a new equilibrium. Some intermediate case arises when α is equal to 0.8. The exporters have an incentive to change its denomination currency from the third currency to the exporters’ currency if β is greater than 0.97 but do not if β is less than 0.955. In the intermediate case, the discount rate plays a critical role on the choice of currency pricing. When we change the value of H to be 1 (that is, no price staggering), the calibration shows that Vt E always exceeds both Vt I and Vt 0 if α ≥ 0.47. Therefore, in the static framework, the exporters’ currency can be a new equilibrium even when half of the new price setters are backward-looking. In contrast, the exporters’ currency can be a new equilibrium in the dynamic framework with staggered price setting only if much larger fraction of the new price setters are forward-looking. This happens because not only backward-looking price setters but also non-price setters keep the old currency pricing when the prices are staggered. This implies that the role of history becomes dominant in the staggered price setting even when a small fraction of the new price setters are backward-looking. It is true even if the degree of heterogeneity is not large.

7. Concluding Remarks

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This paper investigated the choice of invoice currency under exchange rate uncertainty. The analysis was motivated by the fact that the U.S. dollar has historically been the dominant vehicle currency in developing countries. Our theoretical analysis was based on an open economy model of monopolistic competition. When the market is competitive enough, the exporting firms tend to set their prices not to deviate from those of the competitors. As a result, when the other exporters are expected to set their prices in a third currency, the exporting firm tends to choose the third currency as an equilibrium invoice currency. In particular, in the staggered price-setting framework, history becomes a key determinant of the equilibrium currency pricing when the firms discount future profits, particularly in the competitive local market. The result may explain why the firm tends to choose the U.S. dollar as the vehicle currency when history does matter. For analytical tractability, we used several assumptions in the model. Although the simplified assumptions allowed us to focus an essential aspect on the determinants of currency pricing, our paper may have neglected several other important aspects. For example, we solely focused on the case where exporters have monopoly power but importers do not. We also ruled out the case where the third country trades with “exporters” and “importers”. If importers have monopoly power, the

importers’ currency pricing (local currency pricing, LCP) may be more likely to be chosen. Allowing international trades with the third country, “exporters” may be more likely to choose vehicle currency pricing (VCP) in the international trades with other countries. The extensions are our important agenda for our future researches. One of the motivations of the paper was based on the fact that the US dollar has been the dominant invoice currency in several East Asian countries. However, the dominant role of the US dollar had also prevailed in Japanese exports until very recently. As Japanese economy showed remarkable growth, the role of Japan’s exports in international trade increased substantially in the 1960s and the 1970s. The share of the Japanese Yen’s denomination in the Japan’s exports, however, had been negligible until the early 1970s. Table 7 reports time-series data of invoice currency data in Japan’s exports. The Yen’s invoice ratios were close to zero in the early 1970s and were less than 20% throughout the 1970s. It was 1983 when the Yen’s share exceeded 40% in the Japan’s exports to the world. But the Yen’s invoice ratios were not far above 40% even in the early 1990s and declined below 40% throughout the 1990s. The Yen’s ratios in the exports were not high even for East Asia, although they were slightly higher than for the rest of the world. In explaining the determinants of invoice currencies in Japan’s exports, we may point out several factors that were not discussed in the paper. The first is the heavy reliance of Japan’s exports on the United States. Since only a small fraction (16 percent in 1991) of Japanese exports to the United States are invoiced in the yen and since a large fraction of Japanese exports go to the United States, the structure of Japan’s exports leads to relatively low yen-denominated invoice currency ratios in

15

Japan’s total exports. The structure may affect the choice of invoice currency on Japan’s exports to the other countries. The second is the relatively small size of the short-term capital market in Japan. Although its volume has been increasing recently, the size of the treasury bill market in Japan is still much smaller than in the United States. Since the short-term capital market would be where foreign investors would park their yen-denominated funds, its limited size reduces the invoice currency ratio of the yen in trade. The third is the role of Japan’s large trading companies, which handle the bulk of Japanese exports and imports. Since these companies have a relative advantage in avoiding foreign exchange risks, their existence may lead to relatively low yen-denominated invoice currency ratios in Japan’s total exports. However, in addition to these factors, it is likely that both history and expectations have been the important factors. Due to the previous economic power, the U.S. dollar still plays an important role in Japan’s international trade. The expectations support the inertia. Although Japan’s economic power in world trade has risen, it would be a long way for the yen to be the key currency in world trade.

16

References

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Donnenfeld, S., and A. Haug, (2003), "Currency Invoicing in International Trade: An Empirical Investigation" Review of International Economics, Vol. 11, pp. 332-345. Frankel, J.A., and S.-J. Wei, (1994), “Yen Bloc or Dollar Bloc: Exchange Rate Policies of the East Asian Economies," in T. Ito and A. O. Krueger eds., Macroeconomic Linkage, Chicago: University of Chicago Press.

Frankel, J., D. Parsley and S.-J. Wei, (2004), "Slow Passthrough Around the World: A New Import for Developing Countries?" working paper, KSG Harvard University. Friberg, R., (1998), “In Which Currency Should Exporters Set Their Prices?” Journal of International Economics 45, pp.59-76. Fukuda, S., (1995), "The Structural Determinants of Invoice Currencies in Japan: The Case of Foreign Trades with East Asian Countries" in T. Ito and A. O. Krueger eds., Financial Deregulation and Integration in East Asia, Chicago: University of Chicago Press. Fukuda, S.,and Ji Cong (1994),"On the Choice of Invoice Currency: The PTM Approach," Journal of the Japanese and International Economies 8, pp.511-529. Fukuda, S.,and M. Ono, (2005), “The Choice of Invoice Currency under Exchange Rate Uncertainty: Theory and Evidence from Korea,” Journal of the Korean Economy, forthcoming. Giovannini, A., (1988), “Exchange Rates and Traded Goods Prices,” Journal of International Economics 24, pp.45-68. Goldberg, L.S., and C. Tille, (2005), “Vehicle Currency Use in International Trade,” NBER Working Papers #11127.

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Ito, T., (1993), “The Yen and the International Monetary System," in C.F. Bergsten and M. Noland eds. Pacific Dynamism and International Monetary System, Institute of International Economics. Kawai, M., (1996), "The Japanese Yen as an International Currency: Performance and Prospects," in R. Sato and H. Hori eds., Organization, Performance, and Equity: Perspectives on the Japanese Economy, Kluwer Academic Publishers, Boston, pp.334-387. Krugman, P., (1984), “Vehicle Currencies and the Structure of International Exchange,” Journal of Money, Credit and Banking 12, pp.503-526. Krugman, P., (1991), “History versus Expectations,” Quarterly Journal of Economics, 106, pp. 651-67. Magee, S.P., and R.K.S. Rao (1980), “Vehicle and Nonvehicle Currencies in International Trade,” American Economic Review 70, pp.368-373. Matsuyama, K., N. Kiyotaki, and A. Matsui, (1993), “Toward a Theory of International Currency," Review of Economic Studies, 60, pp.283-307. McKinnon, R., (1979), Money in International Exchange: The Convertible Currency System, Oxford: Oxford University Press. Oi, H., A. Otani, and T. Shirota, (2004), “The Choice of Invoice Currency in International Trade: Implications for the Internationalization of the Yen” Monetary and Economic Studies (March) pp.27-63. Rey, H., (2001), “International Trade and Currency Exchange,” Review of Economic Studies 68, pp.443-464. Taylor, J.B., (1980), “Aggregate Dynamics and Staggered Contracts,” Journal of Political Economy, 88, pp. 1-23. Taylor, J.B., (2000), “Low Inflation, Pass-through, and the Pricing Power of Firms,” European Economic Review, 44, pp. 1389-1408. Wilander, F., (2004), “An Empirical Analysis of the Currency Denomination in International Trade,” working paper, Stockholm School of Economics.

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Appendix: Derivations of (11)-(13). Equations (1)-(3) and (6) imply that ∂ΠE/∂ P* = ∂ΠI/∂ P* = ∂Π0/∂ P*, ∂ΠI/∂ P*∂ s = ∂Π0/∂ P*∂ s and ∂2ΠE/∂2 P* = ∂2ΠI/∂2 P* = ∂2Π0/∂2 P* at s0 = E s0 and s = E s. It thus holds that when ∂P*/∂ s = 0, (A1) Π11E = Π11I = (∂2ΠE/∂2 P*)(∂P*/∂ s0)2 + (∂ΠE/∂ P*)(∂2P*/∂2 s0), (A2) Π110 = [Π11E + ∂2Π0/∂ s02 + 2 (∂2Π0/∂ P*∂ s0)(∂P*/∂ s0)](∂P*/∂ s0) + (∂2Π0/∂ s02)(∂P*/∂ s), (A3) Π22I = Π220 = (∂2ΠI/∂2 P*)(∂P*/∂ s)2 + (∂ΠI/∂ P*)(∂2P*/∂2 s) + 2 (∂2ΠI/∂ P*∂ s)(∂P*/∂ s), (A4) Π22E = (∂2ΠE/∂ s2)(∂P*/∂ s0) + [Π22I + ∂2ΠE/∂ s2 + 2 [(∂2ΠE/∂ P*∂ s) - (∂2ΠI/∂ P*∂ s)](∂P*/∂ s)]( ∂P*/∂ s)

at s0 = E s0 and s = E s. Since equation (10) lead to (A5) [E U(Π0) - E U (ΠI)]/ U′(Π*) = (1/2) [(Π110 - Π11I) σ02 + (Π220 - Π22I) σ2], (A6) [E U(Π0) - E U (ΠE)]/ U′(Π*) = (1/2) [(Π110 - Π11E) σ02 + (Π220 - Π22E) σ2], (A7) [E U(ΠI) - E U (ΠE)]/ U′(Π*) = (1/2) [(Π11I - Π11E) σ02 + (Π22I - Π22E) σ2],

we can derive that (A8) [E U(Π0) - E U (ΠI)]/ U′(Π*) = (1/2)(∂P*/∂ s0)[∂2Π0/∂ s02 + 2 (∂2Π0/∂ P*∂ s0)(∂P*/∂ s0)] σ02 + (1/2) (∂P*/∂ s) (∂2Π0/∂ s02) σ02, (A9) [E U(Π0) - E U (ΠE)]/ U′(Π*) = (1/2) (∂P*/∂ s0) {[∂2Π0/∂ s02 + 2 (∂2Π0/∂ P*∂ s0)(∂P*/∂ s0)] σ02 – (∂2ΠE/∂ s2) σ2} + (1/2) (∂P*/∂ s) ((∂2Π0/∂ s02) σ02 – {∂2ΠE/∂ s2 + 2 [(∂2ΠE/∂ P*∂ s) - (∂2ΠI/∂ P*∂ s)](∂P*/∂ s)} σ2), (A10) [E U(ΠI) - E U (ΠE)]/ U′(Π*) = - (1/2) (∂P*/∂ s0) (∂2ΠE/∂ s2) σ2 – (1/2) (∂P*/∂ s){∂2ΠE/∂ s2 + 2 [(∂2ΠE/∂ P*∂ s) - (∂2ΠI/∂ P*∂ s)](∂P*/∂ s)} σ2.

Equations (7), (8), and (9) lead to (A11) ∂ΠE/∂ s = A µ pE 1-µ sµ-1 P* µ – µη AηB sµη-1 (P*/pE)µη, (A12) ∂ΠI/∂ s = A pI

1-µ-

P* µ,

(A13) ∂Π0/∂ s0 = A (µ-1) s p0 1-µ s0µ-2 P* µ – µη AηB s0µη-1 (P*/p0)µη,

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Since P* E s = pE = pI E s = p0(E s /E s0) = Aη-1B µη/(µ-1) at s0 = E s0 and s = E s, it holds that (A14) ∂2Π0/∂ s02 = (µ-1) (µ-2) A s p0 s0-3 (P* s0/p0)µ – µη(µη-1) AηB s0-2 (P* s0/p0)µη, = (1/s0) 2 [(µ-1) (µ-2) A p0 (s/s0) – µη AηB (µη-1)], = - (1/s0) 2 pE A (µ-1)[ µ(η-1) + 1] < 0 (A15) ∂2ΠE/∂ s2 = µ (µ-1) A pE s-2 (P* s/pE)µ – µη AηB (µη-1)s-2 (P* s/pE)µη, = (1/s) 2 [µ (µ-1) A pE s-2 – µη AηB (µη-1)], = - (1/s) 2 pE A (µ-1)[ µ(η-1) - 1], (A16) ∂2Π0/∂ P*∂ s0 = A µ (µ-1) (s/s0) (P* s0/p0)µ-1 – (µη) 2 AηB (1/p0) (P* s0/p0)µη-1, = (1/p0) [A µ (µ-1) (p0 s/s0) – (µη) 2 AηB], = - (pE/p0) A (µ-1) µ(η-1) < 0, (A17) ∂2ΠE/∂ P*∂ s = A µ2 (P* s/pE)µ-1 – (µη) 2 AηB (1/ pE) (P*/ s pE)µη-1, = A µ2 – (µη) 2 AηB (1/ pE), = - A µ[µ(η-1) - η], (A18) ∂2ΠI/∂ P*∂ s = Aµ (P*/pI) µ-1 = A µ .

These equations lead to the second part of equations (11)-(13).

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Table 1. Structure of Export Receipts in Thailand (Percent share)

Currencies US dollar baht Japanese yen Deutsche mark Pound sterling Euro Singapore dollar Others Total

1993 91.8 0.9 3.9 1.0 0.8 0.0 0.8 0.8 100.0

1994 90.5 1.6 4.7 0.8 0.6 0.0 0.7 1.1 100.0

1995 91.0 2.4 4.1 0.5 0.3 0.0 0.5 1.2 100.0

1996 91.7 1.3 4.5 0.5 0.4 0.0 0.4 1.2 100.0

1997 92.0 2.1 3.3 0.4 0.3 0.0 0.4 1.5 100.0

1999 87.6 3.7 5.2 1.5 0.3 0.2 0.3 1.2 100.0

2000 87.0 3.9 5.7 1.2 0.2 0.6 0.2 1.2 100.0

2001 85.7 4.0 5.6 0.8 0.3 2.0 0.3 1.3 100.0

2002 84.7 4.3 6.0 0.0 0.3 3.2 0.3 1.2 100.0

2003 84.4 5.0 5.9 0.0 0.3 2.7 0.3 1.4 100.0

Currencies US dollar baht Japanese yen Deutsche mark Pound sterling Euro Singapore dollar Others Total

Sources) The Bank of Thailand.

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1998 90.6 2.6 3.7 0.7 0.4 0.0 0.3 1.7 100.0

Table 2. Structure of export receipts from major trading partners classified by currency in Thailand (Percent share)

USD 71.8 USD

2001 JPY 20.5 JPY

THB 7.3 THB

USD 71.0 USD

2002 JPY 20.9 JPY

THB 7.4 THB

97.1 97.3 99.7 97.1

0.3 0.0 0.0 0.3

2.6 0.2 0.2 2.5

96.4 97.3 98.1 96.4

0.4 0.2 0.0 0.4

3.2 0.3 0.2 3.0

Partner Country European Union - Belgium - Denmark - France - Germany - Greece - Ireland - Italy - Luxembourg - Netherlands - Portugal - Spain - United Kingdom - Austria - Sweden - Finland Total

USD

GBP

74.5 92.8 87.2 50.1 81.7 96.6 83.4 16.7 61.4 74.1 81.4 88.5 41.2 88.7 91.2 73.0

2.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.2 6.8 0.0 0.1 0.0 2.1

Partner Country ASEAN - Singapore - Indonesia - Philippines - Malaysia - Brunei Darussalam - Cambodia - Laos - Myanmar - Vietnam Total

USD

JPY

2002 THB SGD

91.6 79.2 84.2 93.3 64.5 47.0 49.3 65.6 95.9 89.0

2.2 2.8 1.9 1.1 0.4 0.2 0.2 0.2 0.5 1.9

3.3 10.3 5.9 3.8 9.3 52.0 49.9 33.7 3.5 6.1

Partner Country Japan NAFTA - USA - Canada - Mexico Total

Sources) The Bank of Thailand.

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2002 DEM THB EURO Others 0.0 0.0 0.0 0.2 0.0 0.1 0.0 0.0 0.0 0.7 0.1 0.0 0.2 0.0 0.0 0.1

1.8 2.6 0.8 1.1 0.6 0.0 0.5 0.0 0.3 0.2 0.4 2.1 7.5 4.3 0.8 1.3

1.3 0.2 6.8 0.4 25.2 0.4 0.0 0.0 0.0 1.3

21.4 2.6 11.4 47.8 17.6 2.2 15.4 83.1 37.4 24.9 17.7 2.4 50.9 1.2 6.5 22.9

0.3 2.0 0.6 0.8 0.1 1.1 0.7 0.2 0.9 0.1 0.2 0.2 0.2 5.7 1.5 0.6

MYR Others 0.0 0.0 0.0 0.8 0.0 0.0 0.0 0.1 0.0 0.1

1.6 7.5 1.2 0.6 0.6 0.4 0.6 0.4 0.1 1.6

Table 3. The Shares of Payment Currencies in Korean Exports (1) Visible Trade

1976 1980 1985 1990 1992 1994 1996 1997 1998 1999 2000 2001

0.25 1.58 0.76 2.2 2.82 2.58 2.21 1.76 2.66 2.39 1.8 1.47

(Unit: %) Pound 0.37 0.45 0.38 0.87 0.85 0.50 0.98 0.85 0.97 0.95 0.67 0.71

US Dollar Yen Mark 83.86 5.73 2.09 83.45 4.60 0.98 87.78 8.86 0.97 65.58 25.67 2.99 67.79 22.51 3.65 70.08 22.09 3.11 75.48 17.18 2.40 77.22 15.77 2.35 77.79 16.32 1.79 74.52 18.96 1.12 75.87 16.27 0.65 74.38 14.06 0.47

(Unit: %) Pound 0.29 0.39 0.41 2.81 2.06 0.91 0.80 0.99 0.67 1.03 1.23 1.37

US Dollar Yen 99.08 95 94.24 88.21 88.78 88.86 89.1 89.21 88.54 85.61 84.76 87.42

Mark 0 2.15 3.84 7.44 6.25 6.41 5.13 5.02 4.95 5.96 5.39 5.39

(2) Invisible Trade

1976 1980 1985 1990 1992 1994 1996 1997 1998 1999 2000 2001

Sources) The Bank of Korea, Monthly Statistical Bulletin, various issues. 23

Table 4.Korea and Thailand's exports by destination (ratio= exports to an area /exports to the world)

Korean exports

Thai exports

Destination Industrial countries United States Japan Western Europe Canada, Australia, New Zealand Eastern Europe East Asia China:Mainland China:Hong Kong Indonesia Malaysia Philippines Thailand Vietnam Singapore Others South Asia Middle East, Afganistan Western Hemishere Africa, N. Korea, & Area not specified DOTS World Total Industrial countries United States Japan Western Europe Canada, Australia, New Zealand Eastern Europe East Asia China:Mainland China:Hong Kong Indonesia Korea Malaysia Philippines Vietnam Singapore Others South Asia Middle East + Afganistan Western Hemishere Africa, N. Korea, & Area not specified DOTS World Total

1997 41.6% 15.2% 10.3% 13.5% 2.8% 4.4% 35.1% 9.4% 8.1% 2.5% 3.0% 1.8% 1.6% 1.1% 4.0% 3.6% 1.8% 3.4% 5.8% 7.9% 100.0% 54.4% 19.4% 15.2% 16.9% 2.9% 1.0% 36.4% 3.0% 5.9% 2.4% 1.8% 4.3% 1.2% 0.9% 11.1% 5.7% 1.3% 3.4% 1.1% 2.4% 100.0%

1999 50.5% 20.6% 11.0% 15.8% 3.0% 2.7% 32.9% 9.5% 6.3% 1.8% 2.5% 2.2% 1.2% 1.0% 3.4% 4.9% 1.8% 4.2% 5.9% 2.0% 100.0% 57.4% 21.7% 14.1% 17.9% 3.7% 0.9% 32.0% 3.2% 5.1% 1.7% 1.6% 3.6% 1.6% 1.0% 8.7% 5.7% 1.5% 3.5% 1.3% 3.3% 100.0%

Source: IMF DOTS(Direction of trade statistics) Note: South Asia includes Pakistan, Nepal, Indea, Sri Lanka, Bhutan, Bangladesh, and Maldives.

24

2001 48.6% 20.9% 11.0% 13.7% 3.0% 2.7% 33.6% 12.1% 6.3% 2.2% 1.8% 1.7% 1.2% 1.2% 2.7% 4.4% 1.8% 4.6% 6.4% 2.3% 100.0% 56.5% 20.3% 15.3% 17.3% 3.6% 0.9% 33.7% 4.4% 5.1% 2.1% 1.9% 4.2% 1.8% 1.2% 8.1% 5.0% 1.7% 3.3% 1.7% 2.3% 100.0%

Table 5. Components of Export Receipts in Thailand (Percent share) 2001 2002 FX reciepts exchanged to baht 63.9 66.8 Baht receipts through non-residents baht. 4.2 4.7 Payment to foreign creditors 1.0 0.8 Deposit to foreign currency A/C 30.9 27.7 Total 31.9 28.5 Sources) The Bank of Thailand.

25

Table 6. The Discounted Utilities for Alternative Values of α and β (1) α = 1 β

Vt0

0.9 0.8 0.7125 0.71 0.7075 0.705 0.7025 0.7 0.6975 0.695

40.5077 33.2652 28.1094 27.9766 27.8445 27.7131 27.5826 27.4527 27.3236 27.1953

VtE 40.5605 33.2870 28.1111 27.9778 27.8452 27.7134 27.5823 27.4520 27.3225 27.1937

VtI 40.5352 33.2769 28.1107 27.9776 27.8453 27.7137 27.5829 27.4528 27.3235 27.1949

(2) α = 0.9 β 0.9 0.85 0.84 0.83 0.825 0.82 0.815 0.81 0.805 0.8

Vt0 40.5303 36.7111 35.9950 35.2943 34.9496 34.6086 34.2713 33.9377 33.6077 33.2813

VtE 40.5503 36.7189 36.0005 35.2976 34.9518 34.6098 34.2715 33.9369 33.6059 33.2786

26

VtI 40.5410 36.7155 35.9983 35.2964 34.9512 34.6097 34.2719 33.9377 33.6072 33.2804

Table 6. The Discounted Utilities for Alternative Values of α and β (continued) (3) α = 0.8 β 0.99 0.98 0.975 0.97 0.965 0.96 0.955 0.95 0.94 0.93

Vt0 48.5199 47.5603 47.0878 46.6200 46.1569 45.6985 45.2448 44.7957 43.9111 43.0446

VtE 48.5260 47.5642 47.0905 46.6216 46.1575 45.6980 45.2432 44.7930 43.9065 43.0380

VtI 48.5234 47.5628 47.0896 46.6213 46.1576 45.6987 45.2444 44.7948 43.9092 43.0417

(4) α = 0.75 β 1 0.999 0.995 0.99 0.98 0.97 0.96 0.95 0.94 0.93

Vt0 49.5114 49.4126 49.0193 48.5321 47.5722 46.6315 45.7097 44.8065 43.9216 43.0547

VtE 49.4990 49.4000 49.0059 48.5178 47.5561 46.6137 45.6903 44.7855 43.8991 43.0307

VtI 49.5056 49.4066 49.0130 48.5253 47.5645 46.6229 45.7003 44.7963 43.9106 43.0430

Note) Each shaded area denotes the largest utility for each b.

27

Table 7. Invoice Currency Ratios in Japan's Exports For Total World 1969

1970

1971

1972

1973

1974

1975

1976

Yen

0.6

0.9

2.0

8.6

11.3

15.0

17.0

19.4

US dollar

90.1

90.5

90.4

82.8

81

77.7

78.5

76.3

1977

1978

1980

1981

1982

1983

1984

1985

Yen

18.8

19.8

28.9

31.8

33.8

40.5

39.5

39.3

US dollar

76.9

75.4

66.3

62.8

60.9

50.2

53.1

52.2

1986

1987

1988

1989

1990

1991

1992

1993 **

39.9

**

48.6

Yen

35.5

33.4

34.3

34.7

37.5

39.4

40.1

US dollar

53.5

55.2

53.2

52.4

48.8

46.7

46.6

** **

3 1994 Yen

1995

39.7

1996

36.0

35.2

1997 35.8

1998

2000

36.0

US dollar

2001

36.1

-

##

2002

35.6

-

##

##

36.7

-

-

For East Asia 1981

1983

1985

1987

1988

1989

1990

1991

Yen

29.8

48

47.3

41.1

41.2

43.5

48.9

50.8

US dollar

68.9

-

51.3

56.5

56

53.6

48.1

45.9

1992 Yen US dollar

1993

1994

52.3

52.5

-

-

49.0 -

1995 44.3 -

1996 46.3 -

1997 47.0 -

2000

2002 ##

50.0

51.3

-

-

NOTES 1) Unless specified, the data are averaged annually. 2) The data with * show figures for fiscal year. 3) The data with ** show those of September. 4) The data with ## show those of the second half ot the year. SOURCES 1) Exports: Until 1982, Yushutsu Shinyojyo Toukei by Bank of Japan; between 1983 and 1991, Export Confirmation Statistics by MITI. For 1992, Kessai Tuka Douko by MITI. 2) Imports: Until 1980, Yushutsu Syonin Todokede Houkokusho by MITI; Between 1981 and 1985, Houkokusyorei Ni Motoduku Houkoku by Ministry of Finace; Between 1986 and 1991, Import Reporting Statistics by MITI. For 1992, Kessai Tuka Douko by MITI. For 1993, Yusyutu (Yunyu) Houkokusyo Douko by MITI.

28

##

Figure 1-a. Comparison of Each Expected Utility: µ = 5 10.5 10.49 10.48 10.47 10.46 10.45 10.44

third currency

exporters' currency

46

43

40

37

34

31

28

25

22

19

16

13

10

7

4

1

10.43

importer's currency

Figure 1-b. Comparison of Each Expected Utility: µ = 7.5 9.94 9.92 9.9 9.88 9.86 9.84 9.82

third currency

exporters' currency

29

46

43

40

37

34

31

28

25

22

19

16

13

10

7

4

1

9.8

importer's currency

Figure 1-c. Comparison of Each Expected Utility: µ = 10 9.7 9.65 9.6 9.55 9.5 9.45

third currency

exporters' currency

30

46

43

40

37

34

31

28

25

22

19

16

13

10

7

4

1

9.4

importer's currency