By Graham Reid & J R Max Wheel
In recent weeks ahead of the next G7 meeting and January jamboree in Davos, world leaders and finance ministers are increasingly exercised over gyrations in major currencies and the unwillingness of surplus countries to expand demand and permit currency appreciation, a prerequisite for sorting out the global imbalance issues that have dogged the global economy.
President Sarkozy has called for an end to “currency disorder”.
Dominique Strauss-Kahn, the managing director of the International Monetary Fund, restated his view that a new global currency might evolve out of the Special Drawing Right, the Fund’s in-house unit of account. “In a globalised world there is no domestic solution,” he told a forum.
A former IMF chief, Michel Camdessus, said time was of the essence to embark on reform of the global monetary system.
Chinese central bank governor Zhou Xiaochuan has proposed that an expanded SDR could eventually replace the dollar as the global reserve currency.
Joseph Stiglitz’s UN expert panel said an SDR-based reserve system “could contribute to global stability, economic strength, and global equity” and “would be feasible, non-inflationary, and could be easily implemented.”
The UN Conference on Trade and Development (Unctad) 2009 report called for the creation of a new global reserve currency. While calling the dollar-based system a “confidence game” of financial speculation, the UN called for a new global reserve bank to manage the new currency.
The latest is Canada’s Jim Flaherty whose role is important as Canada avoided the worst of the excesses and it is to host the next round of G7 meetings in February and the G20 summit in June.
The writers have long held the (minority) view that the US economic hegemony is over and with it the exclusive role of the US$ as the world’s reserve currency. We have argued that an enhanced role for the IMF and the SDR is essential to prevent currency manipulation by Governments whether by apparent indifference or outright refusal to allow appreciation in a new game of beggar thy neighbour by the major economies.
It is not a new concept. Hang-sheng Cheng, Fed Reserve Bank of San Francisco, wrote an article “Emerging SDR standard?” in 1975 addressing the issue of currency swings when floating exchange rates were a novelty. It points out what it is obvious but which should be taken on board by policy makers again as they tear up their textbooks. Depreciating a currency will obviously make exports cheaper and imports more expensive, but more importantly reduce real incomes and increase domestic inflation, assuming a reasonably open economy.
One landmark effort to “manage” exchange rates was the Plaza Accord of 1985 when a fierce squeeze instigated by Mr. Volcker led to major $ appreciation and ballooning of the US current account deficit, especially with Japan. Coordinated action by the major Central Banks lead to a 51% decline in the value of the US $ against the yen.. The World has moved on since then, for Japan, read China. The chances of another Plaza Accord look very remote. Hence a new standard is needed, the SDR can and should in our view fulfil this role.
The Chinese Government amongst other dissatisfied bodies has openly argued for an SDR standard: whilst this reflects a substantial degree of self interest given the volume of claims denominated in US$ and held as reserves, there is a serious issue behind this call.
A global economy must have a global standard of reserve asset. The US$ cannot usefully provide this any longer, except as part of a wider basket of currencies and possibly commodities.
Each time this is mooted, it is argued that this cannot be achieved. The arguments are part technical, it is a unit of account not a currency, it would have to have liquid spot, forward and futures markets, a proper yield curve like major currencies. The other and far more serious objection is political. Carnegie-Mellon Professor Bennett McCallum addressing the Cato Institute Shadow Open Markets Committee in April 2009 argued that it was foolish to hand over control to the IMF and by extension to the UN, “based on its political structure, which would reduce US influence”. Attempts to try to influence or force surplus countries into currency appreciation are doomed to failure.
This is precisely what is needed; a global system cannot rest on the naked self-interest of a single country. The G20 effort to increase SDR issuance deserved half a cheer, it now needs to look seriously at this alternative to stop countries’ blatant attempts at manipulation and to expand the currency basket to include the currencies of all the significant trading nations as a minimum. One final point: use of an SDR standard would imply an implicit subsidy from surplus to deficit countries. That might just focus minds of the unwilling participants.