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This paper examines the monetary approach to the balance of payments in Barbados, a small open economy with a fixed exchange rate system. We use an error correction mechanism (ECM) approach which shows that the monetary approach applies to Barbados. Such an ECM approach has not been previously employed in other related studies. Our analysis has implications for monetary policy since it confirms that excessive credit expansion leads to balance of payments deficits in fixed exchange rate systems, and the monetary authorities need to hold high levels of reserves in small open economy systems to protect the exchange rate.

Initiated by a central bank, this is the first study to examine and understand the trilemma as well as the quadrilemma monetary policy challenges in the case of Pacific Island countries. Taking Fiji as an example, over the 1975–2013 period, the trilemma, monetary independence and exchange rate stability might have been the more fervently pursued stance; the quadrilemma focus appears to have shifted to foreign reserves and capital account openness. When the full sample period is split into two subsamples, results show that the policy emphasis might have shifted from monetary independence, capital account openness, and foreign reserves to exchange rate stability, monetary independence, and foreign reserves. Policy implications are discussed.

Reality about US-China trade differs much from what is written. For the US, supplying vehicle currency for the growing world trade means a naturally rising over-all deficit, long before China's trade expansion. Improved transportation and communication cause fragmented production in lengthened supply chains. As the last production link, China's value-added share is miniscule to that of Japan or Korea, in China's exports to US (in gross value). Bilateral trade deficit to China is thus natural. This is intensified by China's amassing foreign reserves that suppressed RMB, diverted some trade from Mexico, etc., and shifted jobs long lost to the US. Over two decades, deficit to China has risen from 1/5 to 4/5 of deficit to all East Asia, yet with the latter falling from 100% to 2/3 of the over-all deficit.

This paper uses the fourth generation of Bi-Directional Reiterative Truncated Projected Least Squares (BD-RTPLS4) to estimate the dollar change in exports due to the accumulation of an additional dollar of foreign reserves, ∂(exports)/∂(foreign reserves), for Australia, Bangladesh, China, Hong Kong, India, Indonesia, Japan, Kazakhstan, Pakistan, Singapore, South Korea, Malaysia, New Zealand, the Philippines, Taipei, Thailand, and Vietnam for 1995–2011. The dollar return in exports due to the accumulation of an additional dollar of foreign reserves is falling for most of these countries. Most notably, China's ∂(exports)/∂(foreign reserves) fell from 1.875 dollars of exports in 1995 to 0.493 in 2009 but rose to 0.589 in 2011. An implication of these results is that the current international financial system is no longer sustainable. China, currently weaning itself off of its dependence on exporting, is taking serious action to create consumption driven growth in China, and is gradually losing its capital controls. Once these actions have borne enough fruit, China could buy its own currency on the international market paying for it with its holdings of US dollars (estimated at 1.78 trillion dollars), driving up the value of the Chinese yuan and consequently, causing the value of the dollar to plummet. This might cause the world to switch from using the US dollar as a reserve currency to using the Chinese yuan, and, thereby, lead to China displacing the US as the world's dominant nation.