Wednesday, October 5, 2011


by Ettore Dorrucci and Julie McKay

The current IMS took shape in the years following the Asian crisis (1997-98) and the advent of the euro (1999). This system can be seen as an evolution from the two previous systems, the Bretton Woods system of fixed exchange rates and the subsequent system centred on three major floating currencies (the US dollar, Japanese yen and Deutsche Mark), on which Box 1 provides more detail. Its start was marked by two major developments. The first was the materialisation of a revitalised US dollar area, encompassing the United States and a new group of key creditors which, unlike in the previous phase, had become systemically important: namely, certain economies in emerging East Asia – especially China – and the Gulf oil exporters. Dooley, Folkerts-Landau and Garber (2003) labelled this arrangement the “revived Bretton Woods” or “Bretton Woods II”. We will in turn refer to the current IMS as the “mixed” system, to highlight the assortment of floating and fixed currency regimes of its core actors. The second development was the advent of a major monetary union with a new globally important floating currency, the euro, which – despite some weaknesses inherent in its status as a “currency without a state” – has rapidly become a credible alternative to the US dollar, though without undermining its central role in the IMS.
A core feature of the mixed system is that, in contrast to the Bretton Woods system, there are no longer any rule-based restrictions (e.g. a link to gold) on the supply of international liquidity. It should be noted that, under the current IMS, the supply of international liquidity does not necessarily require the accumulation of current account imbalances, as predicted by the Triffin dilemma. This deserves mention because until 2006-07 the supply of US dollars was associated with US current account deficits that were high and rising (Chart 2). Owing to global financial markets, however, reserve-issuing countries should be able to provide the rest of the world with safe and liquid assets while investing in less liquid and longer-term assets abroad for similar amounts. This would result in maturity transformation in the financial account of the balance of payments while maintaining a balanced current account or, at any rate, a sustainable current account deficit/surplus (Mateos y Lago, Duttagupta and Goyal (2009)). By looking at gross in addition to net assets and liabilities, it is also possible to gauge the importance of other actors in the current IMS, namely the financially mature advanced economies, which are engaged in large-scale cross-border intermediation activity regardless of the sign of their net capital flows, i.e. their current account (Borio and Disyatat 2010). This is a very important and often overlooked aspect as external stability depends on the sustainability not only of the current account (i.e. the savings/investment positions) but also of gross capital flow patterns and the
underlying asset/liability positions (see Broner, Didier, Erce and Schmukler (2010) for an analysis of the importance of gross flows from the 1970s until the present day). Today more than ever, the stability of the IMS is closely related to the stability of the international financial system through this nexus. And indeed many prefer to talk about an international monetary and financial system, given the difficulty of disentangling the two elements.
The ensuing indebtedness of the reserve issuers – or, within the more balanced euro area, of individual members of the Monetary Union as long as it lacks a proper architecture for crisis prevention and resolution – may over the longrun undermine the confidence that is the basis for the reserve asset status, according to Mateoy Lago et al. (2009). This is the classic “Triffin dilemma” revisited. In the words of Gourinchas and Rey (2005), “Triffin’s analysis does not have to rely on the gold-dollar parity to be relevant. Gold or not, the spectre of the Triffin dilemma may still be haunting us!


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