Forty years is enough?

In search of a new international monetary system

14 September 2011

On the 40th anniversary of US default on its gold convertibility obligation, decreasing confidence in the dollar has strengthened calls to reform the international monetary system. The IMF is accused of ignoring inequities at the core of the system, while developing countries are increasingly seeking alternative regional arrangements.

The downgrading of the US government’s credit rating by Standards & Poor’s in early August raised concerns about the stability of the global economy and the credibility of a global reserve system based on the dollar. In response, Chinese official news agency Xinhua called for “international supervision over the issue of US dollars” and the introduction of a “new, stable and secured global reserve currency [as] an option to avert a catastrophe caused by any single country” (see Update 75, 66). Similarly, in mid August Ousmene Mandeng, senior executive at Swiss private bank UBS, argued that “40 years since the US closed the gold window, the international economy may finally conclude that continued reliance on the dollar may simply be too risky”.

Trevor Evans of the Berlin School of Economics and Law in June in the special edition of the International Journal of Labour Research said the euro crisis makes the need for reform even more urgent (see Update 77). The major imbalances in the eurozone mean European countries should “lend their full support to proposals for moving towards a new international monetary system, based on a truly international reserve currency and in which private financial capital flows are strictly controlled”.

the IMF continues to ignore these inequities

Clear evidence of the current volatility of the financial markets and weakening of the dollar and the euro is the strong appreciation of national currencies in Switzerland, Canada and Australia. This led in early September to an unusual move by the Swiss government to peg the Swiss franc against the euro. This induced a devaluation of almost 10 per cent and heralded warnings of a second round of ‘currency wars’ (see Update 73).

In mid August, Barry Eichengreen from the University of California, who until last year was advocating a system based on the dollar and the euro, argued that it is time to find alternatives to these two currencies. He argued for the creation of a “global-GDP-linked bond, the returns on which would vary with global growth rates”. This system “would enable central banks to hold instruments that behave like a widely diversified global equity portfolio”.

Heiner Flassbeck director of the United Nations Conference on Trade and Development (UNCTAD) Division on Globalization and Development Strategies argued in September, that “in the current monetary chaos you cannot have trade that improves the welfare of nations.” To deal with currency speculation and imbalances he argues it is necessary to strengthen international cooperation and create a “rules-based managed floating” exchange rate system. As explained in UNCTAD’s Trade and Development Report 2011, through this system countries would aim to maintain stable real exchange rates by adjusting nominal exchange rates either to inflation or interest rate differentials. Although the system can be practiced unilaterally, bilaterally or as part of regional monetary cooperation, the “greatest benefit for international financial stability would result if the rules for managed floating were applied at the multilateral level, as part of global financial governance.”(see Update 72, 70)

Fund in denial of inequities

Even IMF managing director Christine Lagarde underlined in late July how US government delays in reaching an agreement to lift the nation’s debt limit raised “doubts in the mind of those people who reserve currencies as to whether the dollar is effectively the ultimate and prime currency of reserve”. Despite Lagarde’s acknowledgment, recent IMF work makes very modest proposals. An IMF policy paper released in early April, titled Strengthening the international monetary system: Taking stock and looking ahead, addresses the problems of the current system and presents a set of reform proposals. The paper takes previous IMF evaluations of the role of IMF-held reserve assets – special drawing rights (SDRs) (see Update 74) – a step further arguing that “expanding the stock of SDRs through regular allocations could meet some of the needs for precautionary reserves” and that encouraging its use as a “unit of account to price global trade … could mitigate the impact of exchange rate volatility”.

Stephany Griffith-Jones from Columbia University points out that “by not taking a clear stance or pushing for a structural reform, the Fund is facilitating the inertial solution, i.e. a multicurrency system with flexible exchange rates, which does not solve the main problems of the system, and will harm especially the development prospects of developing countries.”

In a December 2010 lecture former UN under-secretary general for economic affairs José Antonio Ocampo gave central relevance to the inequities inherent in the current system. These inequities are “generated by the need that developing countries face to accumulate foreign exchange reserves to manage the strong pro-cyclical swings of capital flows, which are nothing other than transfers of resources to reserve-issuing countries”. Griffith-Jones argues that “the IMF continues to ignore these inequities showing a limitation to take into account developing countries perspectives”.

The executive board of the Fund is due to hold an informal meeting in early September to discuss a paper on Financial Deepening and Currency Internationalization which will focus on international use of the Chinese yuan, and other emerging market currencies (see Update 72). At the spring meetings in April the Chinese central bank deputy governor said “it is worthwhile to explore the diversification of reserve currencies”, indicating that they are willing to internationalize the yuan, although not in the short run (see Update 75). The next formal IMF executive board meeting that will address these issues is in mid September when the Triennial Surveillance Review will be held.

Alternatives to the IMF: Developing countries strengthen regional arrangements

The lack of progress on monetary system reform at international forums like the IMF means that change is mainly happening at the regional and bilateral level (see Update 66). Brazil, Russia, India, China and South Africa took concrete actions by signing an agreement in April to have their development banks provide credit to one another denominated in their own currencies instead of dollars.

South America is taking a more rapid path with the development of its own currency unit the sucre (see Update 68, 65, 63). An UNCTAD report on regional monetary cooperation in Latin America published in May claims that the sucre can provide “some degree of protection against external shocks … foster trade expansion [and] decouple their currencies from the dollar”. At the same time, in an August article published by Latindadd, a network of NGOs from Latin America, Rodolfo Bejarano said that an initial assessment of the sucre shows increased savings because of not using the dollar and an increase in commerce flows between the countries that are already part of the agreement.

The role of regional funds

In May, Eric Helleiner from the University of Waterloo, argued that by accumulating reserves Asian governments are seeking to protect their countries’ autonomy “from the IMF whose role in the crisis was widely viewed in the region as overly intrusive, counterproductive and too much influenced by US objectives” (see Update 70). A May study by University of Surrey researchers Graham Bird and Alex Mandilaras finds that “to the extent that IMF programmes have the effect of inducing countries to accumulate ‘excessive’ reserves, there is an inconsistency with one of the basic purposes of the Fund to pool international reserves”.

At the Union of South American Nations (UNASUR) meeting in mid August, South American finance ministers agreed to expand participation in the existing Latin American Reserve Fund (FLAR) to create a $20 billion regional reserve pool. This will assist nations in case the global economic crisis deepens. This regional alternative to the IMF was proposed together with further expansion of trade pricing in local currencies instead of dollars and the creation of a regional development bank, the Banco del Sur. In September, Argentina became the fourth country to formally approve the Banco del Sur.

Georgetown University academics Raj Desai and James Vreeland stressed in March: “regionally based economic governance can be more effective in terms of representation, coordination, and crisis-management than the current Bretton Woods institution-dominated system”. The authors make a call to “leaders of the institutions of global governance” to “buttress the viability of regional governance institutions rather than prevent them”. Ocampo likewise concludes that the “links between the IMF and regional arrangements must be subject, therefore, to flexible designs” and the IMF should “make more active use of regional institutions” and “support their creation in other parts of the developing world”.