Prospects for International Monetary Reform*

currenciesAs I see it, international monetary reform has two essential elements.

The first of these is a system for disciplining excessive current account surpluses, such as Keynes sought to introduce at Bretton Woods. There is an important constraint on what is available, caused by the popularity of floating exchange rates with the G20 (in particular, with the US). I take it that we agree that exchange rates are best set by the interaction of governments and markets, and I hope we also regard the adjustable peg as a false solution to this dilemma (on account of its susceptibility to speculative crises).

The G20 has adopted the nihilistic policy of forbidding thought on where the exchange rate ought to be, which foregoes the benefits of government influence entirely. The Palais Royal report suggests as an alternative a practice forbidding countries from intervening  (or otherwise seeking to influence the exchange rate) so as to push it away from its equilibrium value. This, of course, presupposes that we can agree on equilibrium exchange rates. In the world as it now is, defining these is clearly a task for the IMF. The Palais Royal report suggests that the set of exchange rates chosen need to be (a) mutually consistent and (b) consistent with “each country’s internal and external macroeconomic balance”. Elucidating what that implies is precisely the task that I set myself in a forthcoming book (Williamson, International Monetary Reform, Routledge, 2015). Allowing countries to pick their own targets, but limiting the targets countries are entitled to aim for within the range of +/- 3% of GDP, one gets well-defined values for equilibrium real effective exchange rates (REERs).

A rule forbidding countries intervening to push or hold the exchange rate away from equilibrium would prevent countries running sustained current account surpluses greater than 3% of GDP when they had no capital outflow (formerly China), but not when the exchange rate is held down by large capital outflows (formerly Germany). If the private sector repatriates its holdings and they are taken over by the public sector (including in the form of TARGET 2 balances), then Germany also would become subject to IMF discipline. The fear of this occurring at some future date would presumably make a country more reluctant in running a large current account surplus.

I favor replacing the Palais Royal’s emphasis on strengthened surveillance with requirements to follow certain rules. In terms of disciplining current accounts, what I have suggested is that normal countries (special rules apply to members of currency unions) should be disciplined by exchange rate policies.

The second element of international monetary reform may be summarized as

“enthroning the SDR”. By this is meant making the SDR the principal (ideally, the only) reserve asset; establishing the SDR as the intervention medium; and establishing a vibrant private international market in SDRs, in place of the Eurodollar market. In other words, one would realize the dream expressed in the IMF Articles. What are the reasons for desiring to see this reform? (1) To spread the “seigniorage” involved in reserve creation more broadly: IMF quotas are not an ideal mechanism for this purpose, but they are already better than any conceivable alternative, and anyway one expects them to be progressively changed in the future, to match the growing importance of developing countries in the world economy. (2) To put paid once-for-all to the Triffin Dilemma. Since the whole world is the debtor, it is impossible for an increasing demand for reserves to undermine creditworthiness. (3) To provide a bait for the Chinese, who would have to make a major sacrifice to approve the first change, which is central to US interests. But while they are clearly uncomfortable at living in a system dependent on the US dollar and unhappy to see the yuan labeled as inferior to the dollar, they have no desire to see the RMB supplant the dollar.

Replacing the US dollar as the main (or making it the only, if a substitution account can be agreed) reserve asset, making it the intervention medium, and establishing a private market in SDRs are clearly interdependent. One cannot have intervention in SDRs without private holdings of SDRs because intervention inherently involves a transaction between official and private sectors, and if the SDR were used in intervention that would add to the desirability of holding reserves in SDRs. While establishing a private SDR market is essentially up to the private sector, there is much that the public sector could do to nurture the SDR as an “infant currency”, as well as to provide the link between official and private sectors by changing the IMF Articles and nominating one or several commercial banks as SDR holders.

There is a long-running dispute as to whether dollar intervention precludes widespread dollar devaluation. In the run-up to the dollar devaluation of Aug 1971, it was widely assumed by American economists that a dollar devaluation would have no effects on exchange rates because European countries would have maintained their dollar intervention margins unchanged (e.g. Gottfried Haberler and Thomas D. Willett, “A Strategy for US Balance of Payments Policy”, American Enterprise Institute, 1971), although this would have been in direct contravention of their obligations. This view appears to be shared by Mr Zhou, the Governor of the People’s Bank of China, who, in his famous comment on the inadequacies of the international monetary system in 2008, wrote:

When a national currency… is adopted as a reserve currency globally, efforts of the monetary authority issuing such a currency to address its economic imbalances by adjusting exchange rate would be made in vain, as its currency serves as a benchmark for many other currencies.

In the current international monetary “system”, unlike Bretton Woods, countries are perfectly entitled to declare their exchange rates in terms of the dollar, and therefore Mr Zhou’s concerns appear to be solidly based. Only by replacing the dollar as the intervention medium could one ensure that a legal ability to devalue the dollar would be matched with a practical ability, and could one reasonably hold the US to the same standards for managing its payments as other countries.

There are no reforms that could be expected to benefit all countries in the short run. The intent of the above reform program is to respect the vital interests of all parties, and to offer each of them the prospect of long-run gains. Sadly, one has to acknowledge that since a willingness to seek long-run gains irrespective of the short-run is the characteristic of a statesman rather than politician, the prospects of imminent reform do not appear good.

I conceive the essential interests of each of the main parties today to be:

The United States. I regard the overwhelming interest of the US to be establishment of a system that imposes a discipline on surplus countries. Admittedly the system is not ideal from a US standpoint, since a surplus country that exports an equivalent amount of capital escapes the discipline—as it succeeds in exporting capital.

Western Europe. There is neither a gain nor a loss in the short run. But insofar as most of those worried by the Triffin Dilemma tend to be Europeans, there would be a long-run gain.

China. I do not believe that China benefited itself or anyone else by running large surpluses. Instead, insofar as China wants to build a world economy without a dominant role for the dollar (my interpretation of China’s motives), they have a strong interest in enthroning the SDR.

Other developing and emerging market countries. I believe that their primary interest is in gaining a part of the seigniorage that accrues from reserve creation.

Why then am I pessimistic about the chances of real reform? First, because the powers that be, the G20, focus on the short run, which is what one should expect of a body dominated by politicians rather than statesmen. Second, because some countries, like China and Germany, are against disciplining surpluses (which they equate with virtue). There is no reason to regard their surpluses as permanent, but if we postpone reform until they have developed deficits we may he in for a long wait. Third, Europe has no short-run gain (or loss) by replacing the dollar by the SDR, so why go to the trouble? Fourth, the EMs/LDCs (dominated by the big ones)

have turned anti-SDR as a mark of their virility (in contrast to their attitude in the C20), despite this being against their long-run interests.

*  Text of a speech that John Williamson gave at a conference on “The International Monetary System 70 Years after Bretton Woods” in Turin in Nov 2014.

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