Towards a Multipolar International Monetary System?
Most people think of the international monetary system as an architecturally-designed system made in Bretton Woods at the end of the Second World War. This may be true of international financial institutions like the IMF or the World Bank, but the existing system is a messy legacy of rules, regulations and foreign exchange systems and institutions that facilitate trade and payments between countries.
Unlike a national monetary system, where there is one currency issued by the national central bank and national agencies responsible for financial stability, there is currently no global central bank, no global financial regulator and no global ministry of finance. In short, we have global financial markets, but no global mechanism to deal with periodic crises, except through the (sporadic) consensus views of national policy makers.
This was not a problem when the US was the dominant power in the 1950s and 1960s. But this changed when the US dropped the link to gold in 1971. From then on, the international monetary system was largely driven by decisions between the US and Europe, which collectively owned the majority of the voting power in the IMF.
Needless to say, the emerging markets had little say, since they were the major beneficiaries of aid and funding from the IMF and the World Bank. In 1975, the Group of Six (G6) formally came into being, comprising US, UK, France, Germany, Japan, Italy, with Canada being added to form G7 the next year. Basically G7 leaders met regularly and decided most of the decisions for the international monetary system. The G7 accounted for roughly half of world GDP, but essentially ran the global financial system.
The grouping was only widened in 1997 when the heads of the UN, World Bank, IMF and WTO were invited to join the regular G7 meetings. In 1998, Russia was added to form G8, but with the outbreak of the Asian crisis, the need for more global representation led to the formation of G20 in 1999. The G20 collectively account for 80 per cent of world GDP and two-thirds of the world population.
The reason why the international monetary system is not functioning smoothly is that decision-making lies in the hands of sovereign nations, not the global institutions. A unipolar system is alright as long as the dominant power is stable. This is not necessarily true in a multipolar system, because even obvious decisions cannot have consensus, because of different national interests.
If we keep on thinking in national terms about reforming the international monetary system, can we arrive at a more effective system in promoting global trade and payments and maintaining global financial stability?
For example, the debate over the role of the US dollar and the emergence of the RMB is seen as threats to the status quo. This is understandable, but money and finance are not ends in themselves; they are means to the end of achieving global prosperity and stability.
The real question is what is the global financial system supposed to do, and what is the best way to achieve it?
In the immediate postwar period, there was a shortage of US dollars. Hence, the IMF was created to provide liquidity and foreign exchange reserves for postwar reconstruction. The US ran current account surpluses, held most of the world’s gold reserves and everyone wanted dollars. Today, because of the Triffin Dilemma, the continuous US current account deficits have given rise to the global imbalance thought to be the cause of the current crisis.
One theory goes something like this. East Asia went into crisis in the 1990s, built up large foreign exchange reserves and current account surpluses and these surplus savings reduced global interest rates and caused the advanced markets to lose monetary control. However, that is not the complete story. There is increasing awareness that the global shadow banking credit was pumping out leveraged liquidity that may have caused national monetary policies to lose their effectiveness.
In other words, instead of shortage of global liquidity, we have too much liquidity sloshing around global financial markets, so much so that most central banks are debating how to prevent such liquidity creating asset bubbles, banking crises or the over-appreciation of exchange rates that has haunted Japan and East Asia.
You either deal with this through self-insurance, building up large exchange reserves, or you allow the IMF to become the provider of liquidity when you need it. Most countries do not like the IMF imposing stiff conditions and they discovered quickly that the IMF has no teeth when you are not a borrower.
This is the real dilemma of the current international monetary system. Do we seriously want a global institution to re-balance the global economy through carrots and sticks? If so, each nation would have to give up sovereign power to the IMF.
Currently, the IMF cannot fulfill the disciplinary role against the large shareholders nor can it create credit sufficiently to help resolve the growing financial crises. IMF resources are roughly $400 billion. These would have to be increased by a factor of five for it to have sufficient resources to deal with the European debt crisis. No single country nor group of countries can deal with such exponential growth of the global financial system, last measured as $250 trillion in conventional financial assets and $600 trillion in nominal value of derivatives.
In sum, structural issues surrounding the global system need to be thought through, before you consider the technical question of whether surplus country currencies like the RMB should be included in the IMF’s SDR (Special Drawing Rights) basket of currencies as the global reserve currency.
The reality is that no country will forever be in surplus, and sooner or later, deficit countries will have to borrow from the international pool of savings. In the absence of a coherent global consensus on what to do, muddling through from crisis to crisis seems to be the likely way forward.
In short, don’t expect the dollar dominated system to change a lot unless there is another systems crash.
Andrew Sheng is President of the Fung Global Institute.
1.The Financial Times defines the Triffin dilemma, or paradox, as the conflict between the benefits and costs of a country with a reserve currency running a large current account deficit.