Reform options for the global reserve currency system

1. Reform options for the global reserve currency system Ignazio Angeloni, Agnès Bénassy-Quéré, Benjamin Carton, Zsolt Darvas, Christophe Destais, Ludovic Gauvin, Jean Pisani-Ferry, André Sapir, Shahin Vallee DG ECFIN, Brussels, 19 May 2011

2. Why a revival of the debate? Thirty years of apathy. Why a revival now? • Old debate (fix/float) gone • Root cause of global imbalances and the financial crisis (controversial) • Monetary discipline view (no constraint on issuer of reserve currency) • Asset shortage view: shortage of liquid, riskless assets at global level • World allocation of savings • Unprecedented reserve accumulation in emerging world • Efficiency costs: social cost of reserves, South-North capital flows • Disputes over currency pegs, monetary policies, capital controls • US-China dispute over RMB exchange-rate • US-RoW dispute over QE2 • “Currency wars” amongst emerging countries (Latin America vs. East Asia) • Less benign global environment • End of “Great Moderation” raises issue of global monetary policy stance • Post-crisis asymmetries underline need for emancipation of emerging countries’ monetary policies

3. Main flaws of the current regime • Lack of automatic adjustment • Asymmetric adjustment falling mostly on non-US deficit countries • Imperfect capital mobility and exchange-rate flexibility • Uncertainties surrounding emergency liquidity provision • Bilateral: major role in the crisis, but discretionary • Regional: developing but still limited (Europe, East Asia) • Multilateral: in progress, but lack of trust and fear of stigma rightly or wrongly remain, which justifies (or serves as pretext for) self-insurance through reserve accumulation • Dollar-centered IMS increasingly at odds with the global economy • Change in global economic power towards emerging economies • Inadequacy of US monetary policy for fixers • New Triffin dilemma • No clear global anchor • Lack of global discipline a more relevant issue in the post-Great Moderation world

4. Lessons from History • A durable shift of policy priorities from external to internal stability • Which needs to be made consistent with globalization • Several international currencies can coexist • Internationalization depends on size and domestic regulations/institutions/policies • Smooth transition necessitates coordination • International coordination is more the exception than the rule • Plaza, Le Louvre • International liquidity management has always been a problem • Gold shortage, Triffin dilemma • Failure of supra-national attempts: bancor, SDR

5. Global economy is moving fast towards multipolarity Percentage shares of selected countries and areas in world GDP, 1870-2050 (At 2005 exchange rates and prices) Sources: Angus Maddison’s historical statistics and CEPII projections. * Australia (up to 1900), New Zealand (up to 1939), India (up to 1946). Canada is not included as it was already granted significant autonomy in 1867.

6. Monetary implications of power shift with unchanged IMS • Flaws to become more severe as economic centre of gravity moves • Who will provide global anchor? • How large the world demand for US assets? • How willing the US to play hegemonic stability role? • How acute the disputes on exchange rates? • How effective coordination ? • Increasing risks to the stability of the system • Risk of mismatch between US policy and dollar role leading to abrupt diversification away from USD assets • Need to think of alternatives congruent to likely structure of global economy

7. The potential for a multi-currency system

8. The financial and monetary context 10-15 year horizon Continued financial integration • Despite resurgent capital controls • With a continuation of global imbalances • And financial instability Discontinued monetary policy template • Inflation targeting + exchange-rate flexibility no longer the benchmark

9. Three scenarios for the next decade • Scenario 1: Repair and improve • Current system plus: • Enhanced surveillance by IMF/G20 • Efforts to increase flexibility of exchange rates (dirty floats) • Improved safety nets based on existing instruments (FCL, PCL, swap lines, SDR allocations) • Dollar still dominant international currency • Scenario 2: Move towards multipolarity • Same as scenario 1, plus: • RMB convertibility and financial reform, strengthening of euro area • Diversification of reserve asset supply (Asia, Europe) • Regional reserve currencies (for anchor, liquidity provision) • Scenario 3: Enhance multilateralism • Same as scenario 1, plus: • Further SDR development (debt denomination, commodity invoicing, exchange-rate pegs) • IMF role in determining supply of global liquidity • Central bank cooperation on global liquidity management

10. A schematic representation Transformation

11. Criteria for assessment • Efficiency • Economies of scale (limits number of international currencies) • Minimisation of social cost of reserve accumulation • Avoidance of relative price distortions • Stability • Global anchor • Discipline • Limited or manageable exchange-rate volatility • Resilience to shocks • Equity • Symmetry of adjustments • No “exorbitant privilege” without duties • Share of global seignorage • Limitation of policy spillovers • Take into account feasibility • Consistency with evolution of global economy, institutional requirements

12. The assessment in a nutshell

13. Is a multipolar system inherently unstable? Two views • Hegemony stability (Kindelberger, Cohen) • Multipolar system prone to free-riding and instability • Hegemon internalises externalities and enforces adjustment • Acts as ‘conductor of international orchestra’, especially for crisis management • Multipolar stability (Eichengreen) • Models of hegemonic stability do not confirm HS intuition • Competition brings discipline • Unipolar monetary system isn’t more stable in multipolar economic world Differentiate stability concepts • Short-term volatility / decennial crises • Static / dynamic instability: can multipolarity be the end game?

14. Transitional issues • How fast can RMB attain international currency status? • RMB can easily reach today’s international status of the pound or the Swiss franc • To go further, China would need to: open-up its onshore financial account, float its currency, expand its regional monetary role, develop issuance of high quality assets and revamp its financial sector • It would also need to improve its legal framework and trust • Triggers for global rebalancing • Relaxation of Chinese capital controls key to ensure effectiveness of domestic reforms • Exchange-rate regime affects speed of adjustment, not outcome • Exchange-rate volatility • €/$ exchange rate reactive to changes in China under RMB peg on $ • Internationalization of RMB could attenuate these asymmetric effects

15. Implications for the euro area • Perspectives • Multilateralism better than status quo or even to repair and improve • Multipolarity: efficiency, stability, equity,... Responsibility + risk of transition • Bipolarity ($-RMB) almost as good as tripolarity, but for equity • Policy implications • Improve growth outlook, economic governance and financial regulation/supervision • To make the euro a fully-fledge international currency: • Streamline external representation • Address inability to supply reserve assets • Recognize and accept the implications of currency internationalisation

16. Conclusion • Repair is a no-regret strategy • Further strengthening of financial safety nets through enhanced use of existing instruments, including SDR (allocations) • Multilateral surveillance (including of exchange rates and capital controls) • Capital mobility / exchange-rate flexibility between major players • Absent appetite for genuine multilateral solutions, prepare for tripolarity • Participation of RMB in SDR would create venue for cooperation (G5) • Would open way to broader use of SDR (allocations, anchor for pegs, invoicing) • Enhance regional agreements, combine multilateral and regional levels • Beware of disruptions in the transition • Monitor reserve diversification • Effective surveillance can help ensure that reforms keep pace with needs