Monday, August 12, 2013

MOI - EU-China Collaboration in the Reform of the International Monetary System: Much Ado About Nothing?



The global financial crisis has shown that the current international monetarysystem (IMS) suffers from an inherent flaw: it depends on US current account deficits forthe provision of global liquidity. Under this arrangement, peripheral countries in the systemhave to accept periodically the debasement of the US dollar. Thus, there are some mutualincentives for the EU and China to reform the current IMS through cooperation. Inprinciple, both are in favour of stable exchange rates and both are keen to constrain USmacroeconomic profligacy. There have been some efforts toward those objectives betweenChina and the European countries in the past years, especially during the French presidencyof the G20 in 2011. However, there has been no significant progress achieved till now. On the European side, there is not a united and independent Europe which could act as acounter-balance to the US in the reform of the IMS. On the Chinese side, Beijing does notsee Europe as a reliable partner because the latter is deemed as a major vested interest inthe current regime. As a result, the French government has failed to focus the world´s attention on the reform of the IMS during G20 Cannes Summit, and the Chinese government has chosen a more unilateral way to internationalize its own currency.


"The global financial crisis initiated in the United States in 2008 has raised doubts about the efficiency of the current dollar-led international monetary system (IMS). Two main structural theories have been put forward to explain the crisis, each with their respectivereform solutions .  

On the one hand, there is the „savings glut‟ theory (Bernanke 2005; 2011), favoured by policymakers in Washington and great part of the Economics literature, whichsays that the unsustainable overleveraging in the US was induced by the recycling of dollar-denominated savings in surplus economies (especially the East Asian countries,including China) in triple-A safe US debt instruments. This constant inflow of largevolumes of savings (a by-product of East Asian countries maintaining their currenciesartificially low in a neo-mercantilist strategy of export-led growth) suppressed the interestrates on US debt and thus fostered over-consumption and over-indebtedness. To avoid arepeat of this mechanism, the proposed solution is to encourage countries like China to letits currency float freely so that the appropriate market equilibrium can be found and arebalancing of the global economy can be achieved.

On the other hand, there is the „Triffin Dilemma‟ theory (Zhou 2009; Padoa
-Schioppa 2010;Bini-Smaghi 2011), favoured by policymakers in Beijing and a number of high profile European officials, which argues that the crisis is a product of the structural contradictionassociated to any international regime dominated by a national currency. As Triffin (1960) explained already in the era of the Bretton Woods System when the dollar was still linkedto gold, there is an inherent flaw in the dollar standard. In order to provide the necessary liquidity for the global economy, the US needs to run bloating current account deficits. The increase of this deficit, however, undermines the credibility of the global reserve currency.While for some time economists thought that the Triffin Dilemma was just a page in historybooks because it was only valid for a system linked to gold, the recent crisis signifies thevengeance of Triffin. Even in a system where the issuer of the main international currency,in this case the US, adopts a flexible exchange rate regime there is a limit to its liquidity provision. As current events have shown, by increasing its fiscal deficits and expanding substantially its monetary base the US enters the risk of undermining the credibility of the dollar as the global reserve currency. The solution thus is to find a mechanism that can restrain US profligacy. 

Influenced by this second theory, in the wake of the crisis policymakers of the BRICS (Brazil, Russia, India, China and South Africa) countries and the Eurozone have openly called for the end of the currently dollar-dominated IMS. Chinese and French officials haveparticularly been active in this debate. The President of China Hu Jintao, the Governor of the People´s Bank of China (PBoC) Zhou Xiaochuan, and the President of France NicolasSarkozy, have all declared that the flexible-dollar-system is a legacy of the past and that itneeds to be revised. In principle, Europe and China have a number of shared interests in thereform of the IMS. Both are second-tier powers which advocate the creation of a more balanced, regulated and multi-polar monetary system. Both are suspicious of the benefits of unfettered financial markets (with the notable exception of the UK). Both have historically been in favour of a more coordinated exchange rate regime able to mitigate exchange rate misalignments detached from economic fundamentals. And both have resented the fact that the US is able to misuse its exorbitant privilege as the issuer of the global reserve currency.In other words, both China and Europe would like to create a mechanism that enforcesmacroeconomic discipline upon the US..."


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