THE COMING GLOBAL MONETARY DISORDER

1. THE COMING GLOBAL MONETARY DISORDER • Benjamin J. Cohen • University of California, Santa Barbara • Remarks Prepared for presentation at the Fundación Rafael del Pino, • Madrid, Spain, 19 May 2014

2. EXECUTIVE SUMMARY • Question: What is the outlook for the international monetary system (IMS)? • Answer: More disorder (most likely scenario) • Why? A growing sense of complacency, due to – • Overestimation of economic recovery • Underestimation of future risks • What can we do? • Strengthen commitment to growth • Promote greater policy cooperation • But can we do it?

3. CAVEAT • Not everyone is complacent • IMF (“Global Agenda”, April): “The global recovery has strengthened but remains far from robust” • The Economist (May 10th)warns that we “still face testing times” • Christine Lagarde (May 12th) warns of “deceiving calm” • But the signs of growing complacency are evident • Capital is flowing back into European periphery; sovereign borrowing cost are dropping; spreads are narrowing • Ireland and Portugal have made a “clean exit” from their bail-outs, forgoing the safety net of a precautionary line of credit • Central banks are pulling back (US, UK) or standing pat (ECB)

4. THE GOOD NEWS • The economic recovery is gaining strength • Latest forecasts (IMF): 2013 2014 2015 • World 3.0 3.6 3.9 • USA 1.9 2.8 3.0 • Euro area -0.5 1.2 1.5 • Germany 0.5 1.7 1.8 • France 0.3 1.0 1.5 • Italy -1.9 0.6 1.1 • Spain -1.2 0.9 1.0 • United Kingdom 1.8 2.9 2.5 • Japan 1.5 1.4 1.0 • China 7.7 7.5 7.3

5. THE BAD NEWS • Growth projections may be too optimistic • Even if accurate, they are hardly impressive • Global growth is still well below potential • GDP in most advanced economies is still below 2008 • Unemployment is still very high • Threat of deflation (“lowflation”) • “Secular stagnation”? • Worst: they underestimate three major dangers in the IMS • Exchange rate instability (“currency wars”?) • Peak currency competition (dollar crisis?) • Erosion of monetary cooperation (breakdown of governance?)

6. CURRENCY WARS? • An old problem: temptation to manipulate exchange rates • In principle, outlawed by IMF Article IV, “firm” surveillance • In practice, surveillance is ineffectual; governments do what they want (“dirty floats”) • Direct intervention in the foreign-exchange market • Monetary policy (interest rates, money supply) • Capital controls

7. WHY IS SURVEILLANCE INEFFECTIVE? • Motivations are difficult to assess: Is an ER movement the aim of policy or an incidental b-product? Examples: • US: Federal Reserve’s QE2 • Japan: “Abenomics” • China (and other Asian nations): reserve accumulations – insurance or ER manipulation? • State sovereignty: IMF has little real authority to enforce the rules • Result: danger of renewed currency war • Aggravated by sluggish recovery • In turn, retards recovery (inhibiting adjustment, increasing volatility and uncertainty )

8. DOLLAR CRISIS? • Central role of the US dollar: good or bad? • Good: Stabilizing “hegemon” • Bad: Destabilizing monopolist (“exorbitant privilege”) • Answer: both (but more good than bad) • Trend toward a multi-currency system: good or bad? • Good: Would impose discipline on the US • Bad: Would provoke competition, destabilizing shifts of confidence • Answer: again both (more bad than good) • Real question: Are there any real challengers to the dollar? • Two possible candidates: euro and yuan (renminbi, RMB) • Answer: NO, BUT… • Neither is a threat to the dollar at the global level • But each will challenge at the regional level (an “asymmetrical multipolar system”) • Challenge will be sufficient to threaten greater instability

9. THE EURO • Potential as an int’l currency remains unrealized. • Why? Flawed from the start – an asymmetrical distribution of authority (monetary centralization, fiscal decentralization) – hence no credible mechanism to deal with internal payments problems • Ideal solution: a “transfer union” (mutualization of risk) on model of US • Balanced budgets • Bail-out ban • Automatic transfers • European “solution” – combination of • Fiscal limits (Stability and Growth Pact, now Fiscal Compact) • Bail-out ban, now European Stability Mechanism (ESM) • But NO automatic transfers • Result: persistent crisis, anti-growth bias

10. ANTI-GROWTH BIAS • Without automatic transfers, each imbalance crisis must be negotiated • Adjustment pressures tend to fall on debtors • [Keynes: “the process of adjustment is compulsory for the debtor and voluntary for the creditor”] • Only choice: “internal devaluation” (austerity) – hence an anti-growth bias • In short, an updated version of the gold standard without gold – a “cross of euros.”

11. IS THE EURO DOOMED? • Neither success nor failure • Centripetal force: commitment to union, fear of consequences of breakdown • Centrifugal force: imperatives of sovereignty • Result: an uneasy, untidy series of compromises, limiting the appeal of the euro as an alternative to the dollar • Nevertheless, the euro will be a challenge to the dollar in its own neighborhood – a potentially destabilizing competition

12. THE YUAN • A serious rival to the dollar? Clearly a Chinese goal • China’s strategy (choice of goals) • Two tracks • Trade (swap agreements, trade invoicing) • Finance (bank and bond markets in Hong Kong) • Well conceived – stresses most important roles (trade, investment, reserves) • China’s statecraft (choice of means) – less well conceived • Until now, reliance on China’s growing economic weight (“gravitational pull”) • Missing: financial development; rule of law • Why? Inconsistent with Chinese political economy model (“Beijing Consensus”) • Conclusion: Will not be a serious threat to the dollar for a long time – but like the euro, will be a challenge to the dollar in China’s own neighborhood – a potentially destabilizing competition

13. GOVERNANCE • Basic requirement: A minimum degree of policy cooperation; impossible without – • A consensus on basic principles • Effective leadership by dominant monetary powers • Neither seems evident today • IMF • Promising reforms were agreed in 2010 • But implementation has been blocked by the US (specifically, Republicans) • Result: pressures by BRICS, others to move on without the US – IMF could split • Group of 20 • Newly designated as the central locus of monetary governance • But few accomplishments • Reasons • Lack of consensus • Few have been willing to take the responsibility to lead • Result: drift, risk of rising policy conflict

14. CONCLUSION • No reason to be complacent • Improvements have been overestimated • Risks are underestimated • High risk of growing monetary disorder • What can we do? • Strengthen commitment to growth • Promote greater policy cooperation • Easier said than done • Be prepared!