## Toward a Multipolar System

## Source details

**Canonical URL:** [Toward a Multipolar System](https://www.imf.org/-/media/files/publications/fandd/article/2019/june/new-monetary-system-farhi.pdf)

## Other formats

- [Markdown version](/-/media/files/publications/fandd/article/2019/june/new-monetary-system-farhi.pdf.md)
- [Structured JSON version](/-/media/files/publications/fandd/article/2019/june/new-monetary-system-farhi.pdf.json)

---

### Summary of current system and dollar dominance
- The international monetary system has undergone several transformations over the past two centuries, moving from the gold standard to the current arrangement of flexible exchange rates.
- Historically, the system was almost always dominated by a single currency: until World War I, the pound sterling; a turbulent sterling-dollar era between the two world wars; and the dollar ultimately prevailing following World War II.
- The reign of the dollar survived the end of the dollar exchange standard instituted by the Bretton Woods Agreement and emerged from the global financial crisis even stronger than before.
- Today, the dominance of the dollar makes the United States the world’s banker, granting it “exorbitant privileges” and imposing “exorbitant duties.”
- The United States is described as:
  - the preeminent supplier of safe and liquid assets to the rest of the world,
  - the issuer of the dominant currency of trade invoicing,
  - the strongest force in global monetary policy,
  - the main lender of last resort.
- These attributes reinforce one another: dollar dominance in trade invoicing increases dollar borrowing, which increases dollar pricing, which increases desirability and responsibility of the United States in crises.

### Risks and systemic pressures
- There is a growing and seemingly insatiable global demand for safe assets—assets that do not carry a high risk of loss across all types of market cycles.
- The shortage of safe assets has:
  - brought interest rates on relatively risk-free investments down to historically low levels,
  - catalyzed persistent global challenges to macroeconomic stability (by increasing the probability of hitting the zero lower bound),
  - catalyzed persistent global challenges to financial stability (by pushing investors to lever up and take risks to reach for yield).
- A new Triffin dilemma is emerging: over the long run, the only way the United States can accommodate growing global demand for safe assets is by stretching its fiscal and financial capacities, which could strain investors’ trust in the dollar and lead to volatility and self-fulfilling crises.
- The historical mechanism that brought down the Bretton Woods system—forcing the United States to go off gold and float the dollar following a run on its currency—is referenced as analogous.

### Emergence of competitors and transition dynamics
- New competitors such as the euro and the renminbi are emerging and could, in the long run, alleviate the safe asset shortage and the new Triffin dilemma.
- Competition among currencies could make the international monetary system safer and more efficient.
- A truly multipolar international monetary system will not be established overnight: reputation and institutions are not built quickly, and coordination on the status quo can be persistent.
- The monetary instability of the interwar years, when the pound sterling and the dollar coexisted, is a cautionary precedent: as competitors to the dollar emerge, international investors will have places to shift allocations, which could exacerbate destabilizing speculation and lead to self-fulfilling confidence crises.
- Investors should prepare for a potentially disorderly period of transition to a multipolar international monetary system.

### Concrete measures and policy recommendations
- Priority: strengthen the global financial safety net with the dual objective of making the global financial system more resilient and alleviating the global safe asset shortage.
- Preserve the ability of central banks and governments to act as lenders of last resort in their own countries.
- Encourage decentralized arrangements between countries, including:
  - reserve-sharing agreements through which several countries pool their reserves to economize,
  - bilateral swap line agreements between central banks that allow one bank to borrow another’s currency against collateral.
- Bolster existing facilities and expand the financial capacity of the IMF, and strengthen its support to decentralized arrangements.
- More radical proposals for the IMF:
  - centralize reserve-sharing agreements by administering a global deposit facility built on the existing special drawing right,
  - multilateralize the decentralized, sparse, and discretionary network of bilateral central bank swap lines and enhance it with a star-shaped structure,
  - act as a central counterparty clearinghouse and underwriter of bilateral swap lines or offer short-term swap facilities of its own.

### Scenarios and strategic outlook
- In the long run, monetary competition from the euro and the renminbi could resorb the shortage of safe assets, eliminate the new Triffin dilemma, and relieve the United States of some exorbitant duties and privileges.
- In the medium term, increased currency competition could produce more instability akin to the interwar period, driven by investor rebalancing between currencies and potential self-fulfilling runs.
- Preparing now increases resilience should the transition “happen faster than you thought” after taking longer than expected, paraphrasing Rudiger Dornbusch.

*Emmanuel Farhi, Robert C. Waggoner Professor of Economics at Harvard University.*

---


_Source: https://www.imf.org/-/media/files/publications/fandd/article/2019/june/new-monetary-system-farhi.pdf_