The Making of International Monetary Reform

If French President Nicolas Sarkozy had written the prologue to his presidency of the G-20, which has just commenced, he could not have done better. The run-up to the G-20’s summit in Seoul was marred by a series of currency controversies, bringing international monetary reform to the fore. Whereas French intentions to reform the international monetary system had initially been received skeptically, suddenly reform looks like the right priority at the right time. The task is anything but simple. The subject is abstruse. No one outside academia has taken any interest in it for the last 20 years. Accordingly, there are hardly any comprehensive proposals on the table. The United States, for which international monetary reform is synonymous with diminution of the dollar’s global role, is lukewarm. China, which launched the idea, is happy to see the discussion gaining momentum, but lacks precise ideas. As time is on its side, it sees no reason to hurry. Emerging countries hold a similar opinion: they want their current problems to be solved but are not ready to re-write the rules of the game. Japan is keen, but its views on regional monetary cooperation do not match China’s. And Europe is distracted more than ever with its internal crises. Nevertheless, international monetary reform remains a legitimate aspiration. As Vladimir Lenin once reputedly put it, “the surest way to destroy the capitalist system [is] to debauch its currency.” This applies to the world economy today. When the rules of the global monetary game are unclear, inadequate, or obsolete, countries cannot abide by them, and some may attempt to exploit them to their own advantage. This undermines the fabric of international economic relations. The agenda for reform boils down to four key problems. The first is exchange-rate relationships. Developed countries’ currencies have been floating against each other for several decades, but this has been only partly true of emerging and developing countries. Many, especially in Asia and the Persian Gulf, are de facto linked to the dollar, others to the euro. But fixed exchange rates often lead to undervaluation (as in China) or overvaluation (as in Argentina at the beginning of the 2000’s, and, in a different context, several eurozone countries now). And floating and fixed exchange-rate regimes coexist uneasily, because volatility tends to affect the floating currencies (often the euro, and recently the Latin American currencies). So the system needs a reshuffle. The touchstone is currently the renminbi – not so much because of China’s bilateral relationship with the US, but because other emerging and developing countries monitor the renminbi-dollar exchange rate in setting their own policy. China knows that the current situation is not sustainable, but it remains reluctant to move aggressively to let the renminbi strengthen. The second problem is imposing discipline on national policies in order to preempt the temptation to export domestic inflation or unemployment. Under the gold standard, discipline was automatic. With floating exchange rates, it is not. According to an unwritten rule that has emerged over the years, central banks can do as they see fit, as long as they keep inflation stable over the medium term. This rule normally ensures a modicum of coherence and avoids overreactions in exchange rates, but it is insufficient in deflationary times. The US Federal Reserve argues, with some justification, that its quantitative easing is compatible with price stability, while Europe and several emerging countries deem it beggar-thy-neighbor behavior. The problem is that the current context provides no yardstick for assessing when a national policy stops being cooperative. So we need what the jargon calls “surveillance.” This is the International Monetary Fund’s role, but the IMF’s mandate is just that – surveillance, not enforcement. It is also the G-20’s role, but neither the US nor the emerging countries are keen on collective constraints. The third problem concerns international liquidity. Financial flows are excessively volatile. Emerging countries are inundated with capital inflows one day, and faced with abrupt and equally destabilizing outflows the next. To prevent their currencies from appreciating too much in the first case and falling too far in the second, emerging countries have accumulated foreign-exchange reserves, two-thirds of which are denominated in dollars. These reserves now amount to 15% of global GDP, compared to 6% ten years ago. Ultimately, whether this is due to self-insurance or to exchange-rate targeting matters little: yesterday this unproductive growth in reserves was an indirect cause of the crisis; today it is undermining demand. The goal should be to make self-insurance unnecessary by guaranteeing access to international credit lines in case of abrupt outflows of private capital. The IMF started to do this when it created credit facilities without the Fund’s usual (and humiliating) conditionality. But suspicion of the IMF persists, and most countries, especially in Asia, still prefer costly self-insurance to a form of mutualization perceived as uncertain. The fourth problem is collective anchoring. Naturally, the major central banks are concerned with the inflation that they can control – homemade inflation. But this neglects global inflation driven by rising commodity prices, which has been increasingly evident. This was not an issue in the disinflationary environment of the last decade, but it is becoming more of one, which is probably what prompted World Bank President Robert Zoellick’s proposal to restore a role for gold. The notion is absurd – John Maynard Keynes long ago spoke of gold as a “barbarous relic” – but the problem of anchoring global monetary policy and ensuring its alignment with developments in global supply is nonetheless real. The Nobel laureate economist Robert Mundell once compared a monetary regime to a political constitution, because it establishes the rules of the game. The analogy is apt. Unfortunately, it also indicates how ambitious and challenging a task it is to reform the international monetary order. Jean Pisani-Ferry is Director of Bruegel, an international economics think tank, Professor of Economics at Université Paris-Dauphine, and a member of the French Prime Minister’s Council of Economic Analysis. Ends