Is the international monetary system in crisis? If so, what kind of a crisis? And what remedies are needed? These were issues in active debate in the various events surrounding the Annual Meetings of the International Monetary Fund (IMF) and the World Bank that concluded this past weekend.
As with the Edinburgh festival and its associated Fringe, where the latter overshadows the former, the scale and variety of seminars and discussions on the sidelines now eclipse the formal meetings of ministers and officials attempting to provide policy guidance to the two Bretton Woods institutions. While it is excessive to claim that these events shape official opinion, given the scale of attendance (most events played to full houses) it seems reasonable to argue that they at least help crystallise the state of the debate.
In the monetary area, the hot topic was the current state of the exchange rate system. This degree of attention reflects several developments. Given its close link to the trade union movement, there has been a long-running campaign by the Obama administration to compel the Chinese to appreciate the Chinese renminbi (RMB) against the US dollar. This is a campaign that now has the official blessing of the IMF’s managing director, in contrast to the earlier position of the IMF that it was impossible to judge the degree of undervaluation of the RMB.
More recent events include the decision by Japan to intervene in the foreign exchange markets after refraining from doing so for several years (and promising to do more if needed), and a declaration shortly before the meetings by the Brazilian finance minister that countries were engaging in a “currency war”. This formulation was chided as being undiplomatic, even if correct in substance.
An additional factor was the signal by the US Federal Reserve at its last meeting that it may again resort to “quantitative easing” (known as QE2) to guard against the risk of the US slipping into deflation. This move had the expected result of weakening the dollar, and currencies linked with it, such as the RMB.
This concern with exchange rates in the advanced countries, particularly the US, is relatively new. In earlier days, the US adopted a policy of benign neglect towards the external value of the dollar, reflected in the phrase “a strong dollar is good for America” and the famous statement of Treasury Secretary John Connally to the Europeans in the 1970s that “the dollar may be our currency but it is your problem”. Even now, the official position of the European Central Bank (ECB) remains that as an institution created to achieve and preserve price stability, it has no target for the external value of the euro.
Yet, as the discussion at the seminars made clear, household, financial and government sectors in the advanced countries are all engaged in a protracted effort to retrench and consolidate after their past debt excess. This is taking place across all the major advanced economies. There is also massive excessive installed capacity globally, where current output on some estimates is as much as 10 per cent below potential capacity. As a result, even though the corporate non-financial sector is generally in decent financial shape, it has little incentive to invest in additional domestic fixed assets. Multinationals in particular are more likely to invest in the faster-growing emerging markets.
Given the inexorable logic of the demand side of the national accounts, the only remaining source of autonomous demand is growth in net exports. With income growth sluggish, this is more than usually dependent on gains in market share and shifts in relative prices. This explains the intensified recent focus on exchange rates and the associated issues of global imbalances, reserves accumulation, exchange market intervention and reserves diversification.
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Despite this concern, much of it currently directed at China, there was a very wide range of opinions on the underlying defects in the international monetary system revealed by the current tensions, and what, if anything, could be done about it. As with the famous Rorschach inkblot test, I found myself agreeing with speakers who accorded with my own relatively conservative views on both the need for and prospects of deep reform.
Several of these, including Nouriel Roubini of New York University and Ted Truman of the Peterson Institute for International Economics, noted that the underlying problem was an old one, well recognised by Keynes: an international financial system that forces contraction on deficit countries but not expansion on those running surpluses on some measure of current transactions (either trade or the current account) is a system with an innate deflationary bias.
Truman added that the framework for imparting greater symmetry to adjustment in global imbalances already existed in the Fund’s charter, under Article IV, which deals with exchange arrangements. The provisions of that Article for surveillance and exchange adjustment had been routinely ignored by the major members, resulting in the present anarchy, for which the members were largely to blame. This is not unlike the flouting of the Maastricht criteria by Germany and France, the self-appointed custodians of the euro.
Truman also pointed out that the availability of the euro as a viable reserve currency exposed the fallacy of those who argued (as had Robert Triffin in the 1960s, and the Chinese today) that the supply of a reserve currency necessarily implies sustained deficits. The euro area has been largely in current balance over the last decade, yet the euro now constitutes just under 30 per cent of global foreign currency reserve assets. The “exorbitant privilege” of issuing a reserve currency thus consists of seignorage gains (which can be large), but not an unlimited draft on global resources. The fact that the dollar continues to account for the bulk of the remaining reserve assets reflects a voluntary choice made by asset holders, not some monopoly imposed by a global hegemon.
Where might all this lead to? The French assume the chair of the G20 next month, and have promised to make monetary reform the heart of their agenda. Having heard the learned and stimulating discussion of the last few days, my conclusion is that much work will be commissioned, but nothing much will change in the short run. A more stable international monetary system would entail nothing less than the sacrifice of domestic policy objectives to global goals, and there is little sign of this among the major players. Much easier to beat up on China!
The author is director-general, NCAER. The views expressed are personal