Global currencies for tomorrow: A European perspective
A report on options for, and implications of, reforms of the international monetary system prepared for the European Commission in the context of Contract No. ECFIN/220/2010/573686 by a Bruegel and CEPII team composed of:
Ignazio Angeloni, Agnès Bénassy-Quéré, Benjamin Carton,
Zsolt Darvas, Christophe Destais, Jean Pisani-Ferry, André Sapir, and Shahin Vallée
"...After three decades of apathy, the debate on the international monetary system (hereafter IMS) is back. In the 1960s and 1970s, discussions had been raging about international liquidity provision, the pros and cons of abandoning the gold exchange standard, and the initial difficulties of the free-floating regime. In the 1980s, interest had already shrunk to correcting large and persistent exchange-rate misalignments between key currencies. In the 1990s discussions about reforming the IMS virtually disappeared from the international agenda. The focus shifted to more specific issues such as the choice of exchange-rate regimes for emerging and developing countries, the management and resolution of balance-ofpayment and financial crises, and the set-up of regional exchange arrangements, like the euro or the Chiang Mai initiative. Even among scholars, the topic of the international monetary system lost appeal, gradually moving to the realm of economic history. The predominant view was that a market-driven combination of (managed) floating exchange rates, dollar dominance and a lack of a formal global price anchor was the only viable arrangement in a world where internal objectives, such as full employment and price stability, had superseded external ones on a permanent basis.
Four recent developments have led to a revival of the discussion on reforming the IMS:
• One is the rise of global imbalances and their role in the global crisis. A widespread though far from unanimous opinion among academics (see for example Eichengreen, 2009b, Portes 2009) and policymakers (see Larosière, 2009, Turner, 2009 and King, 2010) is that the interplay between macro-imbalances and financial market developments and innovation was an essential ingredient in the genesis of the crisis. There is also broad (but again not unanimous) recognition that macro-imbalances were facilitated by the lack of incentives for policy adjustment and the weakness of multilateral disciplines. Hence, discussion about the prevention of future crises brought IMS reform back on the agenda;
• Second, dissatisfaction with capital flows volatility has revived the debate about the costs and benefits of free capital mobility. The general consensus established in the 1990s about the benefits of financial globalisation has been undermined, not only because of the crisis but also, and more simply, because many emerging countries have been repeatedly overwhelmed by surges of capital inflows followed by sudden outflows. Also, a large set of countries (China, India and a number of emerging economies) have demonstrated that they could perform economically while retaining tight capital controls;
• Third, the accumulation of very large international reserves by still relatively poor countries raises concerns about the welfare cost of holding reserves and capital allocation at global level. Foreign-exchange reserves are mostly invested in high-quality and low-yielding liquid assets. Such an investment strategy has welfare costs for countries that accumulate reserves and it has implications for international capital flows that are undesirable from an allocative viewpoint. Moreover, there is a growing fear among large official reserves holders that the present system exposes them to the risk of large capital losses, should the dollar depreciate in a disorderly way. In brief, foreign-exchange reserves seem to offer an unfavourable risk-return trade-off. Rising concerns in the developing and emerging world were vividly exposed in a widely commented post by China’s central bank governor in March 2009 (Zhou, 2009), in which he unexpectedly called for a reform of the IMS based on a revival of the Special Drawing Rights (SDR);
• Fourth, disputes over the pegging strategies of emerging countries, and monetary policies in the advanced countries, emphasise the increasingly evident need for an emancipation of monetary policies in large emerging countries. The process started before the crisis with the adoption of inflation-targeting monetary policy strategies by many emerging economies. However, fear of floating and collective-action problems led many other countries to maintain the objective of a stable exchange rate and to sterilise the monetary consequences of increased net capital inflows. In the wake of the crisis, the large growth differential between the ‘North’ and the ‘South’ has made such double-target model unworkable without raising barriers to capital flows. These developments have prompted fears of ‘currency wars’.
3.2 Is the current regime unipolar or multipolar?
"...The current regime has alternatively been characterised as a multipolar regime (in which several currencies play international roles) or as a unipolar one (in which there is a dominant international currency). Some authors (for example Rose, 2007) claim that what has emerged from the ashes of the Bretton Woods order is a system in which there is ‘no role for a centre country, the IMF, or gold’, but in which a growing number of advanced and emerging countries have adopted some form of inflation-targeting and float independently. Others (for example Padoa Schioppa, 2010, or, implicitly, Zhou Xiaochuan, 2009) see the current international monetary regime as one where the US retains the privileges (as well as duties) accruing to the issuer of the international currency. Others again (for example Dooley, Folkerts Landau and Garber, 2004) claim that part of the world has moved to a floating regime of the sort described by Rose while another part lives under a revived Bretton Woods regime centred on the US dollar, which leads Aglietta (2010) to call it a semi-dollar standard. To clarify this debate, it is useful to refer to data on the international role of major currencies. Table 2 shows how the use of the euro and that of the dollar have changed between 1999 and 2009. First, the table reveals that the euro has gained importance as a reserve currency for both the official and the private sectors. An analysis of yearly data suggests that this happened primarily in the early years of EMU, while in later years the euro’s shares have stabilised. A parallel increase occurred in the international securities and loan markets. In all dimensions, the euro had by the end of its first decade achieved a significant market share, but it is far from challenging the primacy of the US dollar. For instance, once exchange-rate variations are accounted for, Dorrucci and McKay (2011) show that the share of the dollar in global, allocated foreign-exchange reserves remained stable at around 60 percent between 2002 and 2010, and that of the euro also stable at just below 30 percent. The share of the yen slightly declined (from 5 to 3 percent) while those of the British pound and residual currencies slightly increased. At current exchange rates, the share of the dollar declines but remains largely dominant.
As for the unit-of-account functions, the dollar remains key for commodity and energy markets, although it is less so for manufacturing trade. It also remains dominant for monetary anchoring. For example, Bénassy-Quéré et al (2006) have estimated that, from 1999-2004, 92 percent of a sample of 59 currencies were de facto pegged. Among them, 56 percent were pegged to the US dollar, 14 percent to the euro and 22 percent to a basket.11 For 2007, Goldberg (2010) finds that out of 207 countries, 96 were either dollarised or had their currency pegged to the dollar and another eight were in a managed float against the dollar, resulting in 36 percent of non-US world GDP being linked to the dollar. This is evidence of the importance of the ‘Bretton Woods 2’ regime of Dooley et al (2004)12 and also confirms that the euro is still a regional rather than a global currency (Pisani-Ferry and Posen, 2009). On the whole, the dollar remains the main pivotal currency for all three monetary functions (means of payment, unit of account, store of value), while the euro’s role grew to about onethird/ one-half of that of the dollar in the early years of its existence, but has not developed further in later years. This still-central role of the dollar contrasts strongly with the emergence of a tripolar economy in which the US will weigh no more than either Europe or East Asia in the next decades,..."
Starting from this hybrid system, we review three scenarios for the IMS and assess their implications from various perspectives, including for the EU economy. The three scenarios are the following:
• A repair-and-improve scenario whereby changes to current arrangements are introduced through incremental reforms. These are inter alia enhanced surveillance, a voluntary reform of exchange-rate arrangements, especially in Asia; improved international liquidity facilities; accompanying domestic reforms such as the development of home-currency financial markets; and regional initiatives to complement current IMF facilities. Under this scenario, the international role of key currencies remains broadly constant and the US dollar retains its dominant role, the euro’s role remains broadly unchanged, and the one of the Chinese renminbi increases, but remains marginal in comparison to the dollar and the euro.
• A multipolar scenario in which a system structured around two or three international currencies - presumably the dollar, the euro and the renminbi – emerges over a 10-15 year horizon. Although a move to a multipolar system is generally viewed as a remote prospect, especially in the case of the renminbi, it corresponds to the long-run evolution of the world economy. The Chinese authorities have taken significant steps in this direction through various schemes and their currency has a strong potential for internationalisation. As for the euro, it has already developed as a diversification currency and in this scenario the euro area overcomes its current difficulties and the euro graduates from a mainly regional to a truly global currency. Yet we also examine an alternative bipolar scenario with the dollar and the renminbi which may occur if the euro remains handicapped.
• A multilateral scenario in which participants agree to take steps towards a strengthened international monetary order. In contrast with the multipolar scenario, which will largely rely on market forces and national policies, renewed multilateralism would require a fairly intense degree of international coordination and the development of new instruments to help escape the pitfalls of regimes based on the dominant role of one or a few national currencies, foster macroeconomic discipline and provide for international liquidity management. A system of this sort could build on the existing SDR or rely on other, new vehicles.
While recognising the potential merits of a truly multilateral monetary order, we doubt it could materialise in the foreseeable future and therefore conclude that, at the 10-15 year horizon, the probability of the multipolar scenario is relatively high and that this scenario could contribute to mitigating some (albeit not all) flaws of the present IMS. The transition to a multipolar system however entails some specific risks, such as of an abrupt reserve diversification, that would require tighter coordination during the transition..."
[Mrt: Do I read a timeframe here?]