The Revived Bretton Woods System seen from the Benches - Lessons for Europe from a Three-Asset-Portfolio Model

The paper develops a three-asset-portfolio model to analyse consequences of foreign exchange market operations by Asian central banks on the exchange rates between euro, dollar and yen. Both an analytical as well as a graphical solution is presented. It is found that -- contrary to public belief -- the purchase of dollar assets by Asian central banks strengthens the dollar against both euro and yen. A diversification of Asian central bank reserves from dollar into euro would weaken the dollar against both other currencies. Thus, such a diversification would be incompatible with Asian currency pegs. However, it is shown that Asian central banks could alter their relative portfolio composition while keeping the peg intact if they would shift from intervening against the dollar into intervening against the euro.