The financial crisis has reinvigorated discussion of exchange rate management and reform of the monetary system, but lack of progress at international forums like the IMF means change is only happening at the regional and bilateral level.
The debate over the role of the international monetary system was given a jolt in March when the governor of the People’s Bank of China made a statement calling for an end to the use of the dollar as the world’s reserve currency and a stronger role for the IMF’s special drawing rights (SDRs, see Update 65). Despite playing it low-key in April during the spring meetings, the Chinese have continued to press their case including at the Italian hosted G8 summit in July.
The China Financial Stability Report 2009, released by the central bank at the end of June, made the governor’s speech official policy when it stated: “An international monetary system dominated by a single sovereign currency has intensified the concentration of risk and the spread of the crisis.” The bank urged a rethink of the system and that the IMF exercise closer supervision of the economic and financial policies of major reserve-issuing countries.
An international monetary system dominated by a single sovereign currency has intensified the concentration of risk and the spread of the crisis.
This call was endorsed by Brazil, Russia and India at a summit with China in June, though the Russian finance minister distanced himself from those calls a few days after the meeting. The French finance minister also echoed the demand in July. However, when the IMF, the only international body tasked with monetary affairs, was asked in early July about its thinking on the now three-month-old paper from China, its spokesperson responded: “we don’t have anything that we’ve taken up particularly now. I suppose if it’s put on the table, and we are asked to look at it, we will.”
Professor Jan Kregel of the US-based Levy Economics Institute, who also served as the rapporteur for the UN commission of experts on financial reform, warned that the problem is not the asset that serves as the medium of international exchange or reserves, but the mechanism of countries adjusting to deficits or surpluses. “The introduction of SDRs or another global currency cannot resolve the problem of the adjustment mechanism’s operation. Even the simple creation of a notional currency to be used in a clearing union cannot do this without some commitment to coordinated symmetric adjustment by both surplus and deficit countries. This is a function that was to have been undertaken by the IMF, under its Article IV surveillance mandate, but which has been just as asymmetric as the Bretton Woods system; it is only effective where the IMF has the sanction of a lending program-that is, in deficit countries.”
IMF u-turn on surveillance, not capital controls
China’s massive reserves and fixed exchange rate have long been a topic of conversation, including the IMF consistently saying that the Chinese currency (the yuan) is undervalued (see Update 57). In a riposte to media blaming China for global imbalances that the IMF has been unable to resolve, Terry McKinley, director of the Centre for Development Policy Research (CDPR) in London, argues “that the main source of global instability is to be found in the US, the world’s economically dominant, reserve-currency country-and its most profligate. What is now most problematic is certainly not the current policy response of China to the crisis, but the difficulties faced by the US in correcting its own imbalances.”
China won a victory at the IMF in June. It had been angered by the 2007 decision on surveillance (see Update 57, 56) that included a clause saying that “fundamental misalignment” of exchange rates would be a trigger for additional consultations between the IMF and the country. In late June IMF management quietly admitted in a revised guidance note that this terminology “has proved an impediment to effective implementation of the decision.” The note was published without an accompanying press release or summary of the informal board discussion on the topics that was held in late May. The new guidance “eliminate[s] the requirement to use specific terms such as ‘fundamental misalignment’ and to make a number of other changes that will acknowledge the large degree of judgment required” in exchange rate analysis.
Another briefing by CDPR, authored by Annina Kaltenbrunner and Machiko Nissanke, argues for policies that IMF has continually rejected: intermediate exchange rates regimes and the selective use of capital controls. Based on the Brazilian experience, they suggest combining “a ‘half-independent’ monetary policy with a ‘half-fixed’ exchange rate, namely, some form of intermediate regime. Such a choice would be even more viable, and thus become more credible, if policymakers adopted some degree of management of capital inflows and outflows.” This give countries more flexibility and policy space and may reduce the need to accumuluate large currency reserves that are used to defend fixed exchange rates against speculators.
The IMF has generally been keen to promote all or nothing solutions – meaning either fully liberalised exchange rates or hard pegs – and has been reticent to suggest capital controls (see Update 58). Developing countries find both of the so-called “two corner” solutions difficult: floating exchanges make long-term macroeconomic planning and business investment very difficult; fixed exchange rates are associated with vulnerability to speculation and financial crises. Despite all the recent literature and proposals on exchange rate and capital account management, the Fund has maintained a stony silence. Its staff position paper released in late April, Coping with the crisis: Policy options for emerging market countries, contains the usual long analysis of the need for exchange rate depreciation, and does include a short paragraph on capital controls. However it only warns that countries “could as a last resort regulate capital transactions-though these carry significant risks and long-term costs,” and does not provide any analysis or advice about how to do so. The G77 group of developing countries demanded that the right to use capital controls was reflected in the outcome document for the UN summit on the financial crisis (see Update 66).
Regional initiatives take offf
Impatience with and distrust of the IMF has pushed Asian countries in the ASEAN+3 grouping into finalising the arrangements for their own regional reserve pooling arrangement, the Chiang Mai Initiative. The structure of the so-called multilateralisation of the initiative was decided in May, presenting a challenge to the IMF’s hegemony.
The CMIM, as it is being dubbed, will be worth $120 billion, with 80 per cent of the funds coming from China, Japan and Korea. ASEAN countries will be able to borrow either 2.5 times or 5 times the amount they put in, which is larger than the corresponding normal limits of IMF access, at 3 times quota. An egalitarian governance structure based on the one-country one-vote principle will set the CMIM apart from the IMF. The countries “agreed that an independent surveillance unit will be established as soon as possible to monitor and analyze regional economies and support CMIM decision-making.”
Crucially, the agreement “has not amended the old rule that Chiang Mai Initiative members can freely draw money, without the consent of the IMF, up to 20 percent of the total size of the fund,” according to Oh Yong-Hyup of the Korea Institute for International Economic Policy. “When Asian economies had recourse to IMF loans during the Asian crisis of 1997-1998, this condition was enforceable. However it is not at all clear why this condition should be kept.”
“The idea is for the ASEAN+3 countries to effectively look after ourselves with our own reserves,” Thai finance minister Korn Chatikavanij said at the announcement. The Asian countries promised to have the CMIM up and running by the end of the year.
Future of the yuan
The Chinese, sitting on what most researchers assume to be almost $1.5 trillion worth of dollar-denominated assets, are hedging their bets even further by increasing the international role of their own currency. Over the last six months, the central bank has signed swap arrangements with numerous countries including Hong Kong, Malaysia, Korea, Indonesia, and Argentina. This will allow those countries to extend credit in yuan to their own importers and exporters and thus allow trade with China to be invoiced in yuan rather than dollars. At end June China and Brazil confirmed that they are exploring ways of promoting local-currency invoicing as well.
Chinese journalists Liu Zie and Zhang Chongfang argue in the latest edition of Third World Resurgence magazine, that Chinese officials want “the currency to have a bigger global role but are wary of sudden or excessive change, so they are taking gradual steps to make it easier to use in trade and investment. But any major global role might be as long as 10 to 30 years away, analysts in China admit.”
According to a Reuters report, Li Lianzhong, who heads the economics department of the Communist Party of China’s policy research office, also said in late June that the yuan should eventually be included as one of the currencies in the basket that makes up the SDR, which currently includes the dollar, pound, euro and yen. The next SDR basket review is due in 2010, but unless the Chinese fully liberalise international trade in the yuan, meaning making it a free-floating currency, it cannot meaningfully be included in the SDR basket.
Changes in the international monetary system are coming, with or without the latest moves from China. With the IMF sitting in the stands, seemingly unable to influence the debate, the ball is in China’s court.