The debate over international monetary reform recently garnered attention with the 2007 – 2009 international banking crisis and resulting world recession. While there appears to be a split in the academic community, many economists agree with The Economist (22 January 2008) that ‘the deep causes of the ﬁnancial crisis lie in global imbalances’.
The unsustainable aspects of using a key country’s currency as the international reserve, is known as the Triffin Dilemma and was outlined by Triffin (1960) and Kaldor (1971). Their predictions for inequity and financial instability of such a system are finally coming to bear on the global community. Admittedly, the USD was an improvement on the gold standard in that it imparted enormous liquidity into the system during its 60-year reign. As a liquid and strong currency it allowed countries with well developed financial markets to maintain liquidity and promote growth. But countries without developed financial markets experienced costly monetary jolts that have increased in their frequency and there are growing concerns over the stability of the world financial market centers.
By issuing the international reserve the US was able to ‘deﬁcit spend’ its way out of most economic slumps, and use the high dollar for inﬂation control. The cost of being the world’s banker and providing this ‘international public good’ was born by the real side of the US economy. The strong dollar hobbled its most dynamic growth sector, manufactured exports, and it became dependent on foreign savings and ﬁnancial capitalism. Growing US deﬁcits (in the current account, government and household debt) were ﬁnanced by surpluses in the periphery, and the reserve currency status of the dollar protected US ﬁnanciers when crises struck. Flight to the international reserve allowed much greater elasticity in adjustment in leveraged US entities and financial fragility was exported to the periphery. For example, in the recent crisis net inﬂows into emerging markets was expected to fall from $929 billion in 2007 to $165 billion in 2009 (The Economist 5 February 2009). Such a dramatic decline after years of high capital inﬂow is highly destabilizing.
Any serious loss in the value of the key international reserve currency would precipitate a world-wide shrinkage in credit that would deepen the financial and economic crisis already under way. While most remedial action has been focused on government stimulus and financial regulation, some attention must be given to the monetary aspect that is exacerbating the problem.
There are broadly two types of proposals for global reform in a financially integrated world with free trade. The first, argued by Robert Mundell, is the dramatic reduction of the number of currency unions to three, each with a single key currency (e.g. Euro, Yen and US dollar) fixed to each other and coordinated monetary policy. Mundell argues that such reform could begin with just three key parties, Europe, Japan and the US, at the negotiating table. However this only moves the dependence on a key currency to a basket of key currencies, and it does not remove the inherent instabilities and inequities. Such a system would still be prone to costly financial contagion when the core financial systems, correlated in action, eventually become delinked from any real anchor.
The second set of proposals move beyond the key currency system by creating a credible reserve currency with countries retaining sovereignty over their domestic monetary policy with an option to fix or float their exchange rate to the reserve currency. How to create a universal monetary standard that has real value, not exposed to the perils of speculation, linked to the fundamentals of each industrializing country, yet still allow for independent monetary and fiscal policy essential to absorb idiosyncratic shocks, is a real challenge.
There have been numerous calls to revive the issuance of special drawing rights (SDRs), creating an international reserve unit, under multilateral governance. But these proposals generally remove the credit generating aspect of endogenous key currencies (which, granted, also introduced the procyclical aspect to reserve holdings and exacerbated booms and downturns). Joseph Stiglitz (2006) proposed a system in which new reserves could be created every year and not given largely to the wealthiest countries. He also proposed a liquidity buffer, with SDRs backed by a pool of hard currency under the operation of the IMF. The IMF would give access to exchanging SDRs for hard currencies, or the issuance of SDRs for free, to developing countries or countries with financial difficulties. However this pool of emergency funds still relies on ‘hard currency’ country tax payer contributions and there is no way to ensure that such contributions would be sufficient, nor could the IMF be trusted to offer the appropriate discretionary assistance.
It would be optimal if an automatic and stable monetary system could be set. The spillover effect of keeping ‘hard currencies’ as the backing for a reserve currency is the recycling and procyclicality that it produces. Emerging markets will continue to invest their current account surpluses into strong currency countries (core financial centers). Some portion is returned back to the same creditors in the form of foreign acquisition and ownership of their financial assets and productive facilities. These investments tend to again encourage export-oriented strategies that increase the accumulation of external currencies. Proposals that find ways to recycle these countries’ savings back into their own economies in support of development and internally generated demand will help decouple the North-South growth dynamics, reduce economic contagion, and promote balanced demand driven growth.
Such Keynesian policies have been outlined at various points in history, but have often been ignored. Jane D’Arista has formulated a modern day proposal for an international reserve that is backed by a public international investment fund for emerging economies. Such a currency would be supplemented by an international clearing agency along the lines of Keynes’ Bretton Woods proposal. In addition it could have open market operations in government securities of its member countries similar to Harry D. White’s Bretton Woods proposal, allowing it to operate as a true lender-of-last-resort – a role that the IMF cannot play given its dependence on taxpayer contributions (see D’Arista 2009).
Nicholas Kaldor in 1964 designed an international commodity currency run by an international commodity clearing and storage house. By operating a commodity bufferstock of 30 or so key commodities, whose warehouse receipts would in effect be the new international reserve, the storage program would be self financing. It would help stabilize individual commodity prices through open market operations in the index and act as a non-discretionary automatic stabilizer for the global business cycle, injecting reserves when commodity prices are low and contracting reserves when commodity prices are high. Kaldor set out to build the ideal monetary system to solve what he saw as essentially a coordination problem between countries and industrial sectors: between non-renewable resources with primary production, and the secondary and tertiary sectors of manufacturing and services. His ultimate goal was to create a ‘gadget’ that would act as an apolitical automatic stabilizer that would maintain stable and widespread growth. Predicted benefits were many and far ranging, including the stabilization of costs of production, the balancing of growth between periphery and core countries, and the provision of a real side anchor for financial capitalism.
With growing fears over global warming and national resource security, particularly in the world’s poorest countries, the introduction of a CRC could reduce supply constraints, allow for the long term planning for non-renewable and renewable resources.
While technically difficult the CRC is not more complicated than the auditing of pollution rights. While not boringly feasible nor politically expedient Kaldor deemed his plan as at least logically consistent, taking into account the whole world as a closed dynamic system. Kaldor’s CRC proposal is outlined in a recent paper by Ussher (2009).
A suggested starting point for academics is to build a library of possible plans that can be modified and tested within an agent-based simulation that uses a stock-flow consistent world social accounting matrix such as the open economy macro model of Wynne Godley and Marc Lavoie (2007). Getting the plumbing 'right' such that models match the stylized facts will be half the battle in designing a new international architecture.
(By Leanne Ussher)
Jane D’Arista (2009) “The Evolving International Monetary System,” Cambridge Journal of Economics 33 pp.633-652
Nicholas Kaldor (1971a) “The dollar crisis,” The Times, 67,8 September [reprinted in Further Essays on Applied Economics, London: Duckworth, 1978).
Joseph Stiglitz (2006) Making Globalization Work, W.W. Norton and Co.
Robert Trifﬁn (1960) Gold and the Dollar Crisis (New Haven: Yale University Press).
Leanne Ussher (2009) “Global Imbalances and the Key Currency Regime: The Case for a Commodity Reserve Currency” Review of Political Economy, pp.403-421 Vol 21(3)
Wynne Godley and Marc Lavoie (2007) Monetary Economics: An Integrated Approach to Credit, Money, Income, Production and Wealth, Palgrave Macmillan.