Eichengreen: new book challenges view of inertia in global monetary system, arguing that dollar overtook sterling in one decade after Fed was set up (IMF photo)
INTERNATIONAL MONETARY REFORM
At a discussion on a new book charting the history of the U.S. dollar, participants heard that as the world economy enters a dangerous phase, ensuring the stability of the international monetary system requires implementation of prudent and pragmatic policies.
Against the backdrop of stresses in the core of the global financial system, experts met at the IMF to reflect on lessons for the reform of the international monetary system arising from the book, Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System, by Berkeley economics professor Barry Eichengreen.
Opening the October 19 seminar, IMF Deputy Managing Director Min Zhu noted there is broad consensus that the international monetary system needs reform. “It’s part of the Fund’s mandate to help foster change,” he stated. “We have been reforming surveillance, strengthening the global financial safety net, and even discussing a framework for capital flow management. But how can we deal with the dollar’s dominance to enhance the stability of the international monetary system?”
Commonly understood, the rise of the U.S. dollar derived from the economic size, trade centrality, and open capital account of the United States—features that then give rise to an “incumbency advantage” and inertia in the international monetary system.
Eichengreen’s new work challenges the view of inertia in the international monetary system, arguing that the dollar overtook the pound sterling in just one decade following the formation of the U.S. Federal Reserve. As such, the system can evolve quickly. Like the dollar one hundred years ago, once the prerequisites are in place, currencies of economies that are large and important in global trade and finance can internationalize rapidly.
No dollar alternatives
Speculating how the system might evolve, Eichengreen said the dollar will remain at its center for a long time, not because of its incumbency but simply because alternatives are absent. “Over the next decade, the euro and the Chinese renminbi could emerge as consequential alternatives,” Eichengreen argued. “This evolution should be welcomed, not feared,” as it could result in greater market discipline of policies and foster a better balance between the real economic and financial weights of economies in the system.
Ted Truman, Senior Fellow at the Peterson Institute for International Economics, supported Eichengreen’s observation that at present “the euro is a currency without a state, while the renminbi has too much state.” Outlining the direction of reforms if other currencies were to emerge as major contenders to the dollar, Truman said the euro area must first navigate its current difficulties and large emerging markets implement a range of financial sector and capital market reforms to match their growing economic and trading clout.
Turning to how the stability of the system can be enhanced in the interim, Truman said cited improved surveillance and discipline, not necessarily by reforming reserve currencies. This places the IMF at the forefront of efforts to enhance stability.
Support for stability
In this light, Isabelle Mateos y Lago of the IMF’s Strategy, Policy, and Review Department described a number of initiatives under way to support systemic stability, including enhanced monitoring of country policies and their systemic implications; an improved global financial safety net; and a possible comprehensive and balanced framework for coping with volatile capital flows.
Work has also been under way at the IMF on the longer-term structural strengthening of the international monetary system. Coinciding with the seminar, two Staff Discussion Notes with closely related themes were published: the first explores the scope, risks, and rewards related to the internationalization of emerging market currencies; the second considers the implications of financial sector deepening for the stability of the international monetary system.
The note on currency internationalization argues that there is scope for some emerging market currencies to play a key role in a multipolar international monetary system. In fact, there has been an incipient trend of wider international use of these currencies. Since 2007, the share in official reserves of currencies other than the dollar, euro, sterling, yen, and Swiss franc has tripled. Foreign exchange trading of emerging market currencies and their use to denominate debt issued internationally are also on the rise.
Role for financial deepening
Deepening domestic financial markets and opening capital accounts are prerequisites for further international use of these currencies. But the process of internationalization is not without risks—complicating monetary policy and possibly exacerbating asset price volatility.
The note on financial deepening and international monetary stability finds that, unlike the ongoing convergence in average real incomes, there is a growing divergence in the financial depths of advanced versus emerging markets in recent years—measured by total financial assets and liabilities. While this points to the scope for catching up, there are implications for global imbalances insofar as international adjustment requires slower growth of credit and lower domestic demand in advanced deficit economies, and faster growth of credit and demand in surplus advanced economies and emerging markets.
Deepening domestic financial markets may also involve risks. The incidence and costs of crises appear to rise at early stages of deepening, during which policymakers tend to build reserve buffers, constrain capital mobility, and limit exchange rate flexibility—which, however, may delay adjustment. In later stages, crisis incidence and costs are found to decline in relative terms, alongside flexible exchange rates, open capital accounts, and smaller reserve buffers.
Seminar participants heard that alongside reforms to deepen domestic financial markets in emerging market economies and promote emerging market currency internationalization, stability of the international monetary system will require vigilant monitoring of—and dialogue on—policies, and building a strong global financial safety net.
■ Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System, by Barry Eichengreen, Oxford University Press.
