7 Characteristics of good International Monetary System
On the improvement and reform of international monetary system, I would like to make three points.
First, what is a good international monetary system? If we want to make reforms and improvements to the
international monetary system, they must promote the characteristics that such a system should have. I suggest the following seven characteristics of a good international monetary system:
1) It should promote development, which means that the system can facilitate trade and investment.
2) It should provide correct incentives for those who work hard, so their efforts can pay-off. This means,
whether the country is big or small, and regardless of its region or religious makeup, et cetera, it should provide the right incentives.
3) It should be able to do the adjustment when the balance of payment is imbalanced. International history
suggests that countries compete for different reasons,some based on mercantilism (and a positive balance of
trade) others to make their money cheap. The system should be able to provide a mechanism to adjust each of these kinds of imbalances.
4) It should be able to provide a safety net so that during a crisis it can provide the necessary liquidity to deal
with the crisis.
5) It should have an accurate representation of the world and reflect the world economic fundamentals.
6) It should be stable and resilient against all kinds of shocks—economic, political and otherwise.
7) It should contribute to maintain the stability of exchange rates and effective regional arrangements.
If we consider human history for the last 100 or more years, we have experienced the gold standard, the Bretton Woods system and also the post-Bretton Woods (Jamaica Accord). Each of these different versions of the international monetary system can address some problems better than others. A desirable system should find an efficient balance between the strengths and weaknesses of the various systems.
The second remark I want to make is that if we know what a good international monetary system should look like, the next step is deciding how to reform the current international monetary system accordingly. Before we answer that question we have to ask, »What are the vulnerable points, the shortcomings of the current system?
We need to focus our surveillance on those points in order to prevent another crisis. The Lehman Brothers
crisis of 2008 shows that a lack of financial supervision is a vulnerable point that can trigger systemic risk.
Another example is the sovereign debt crisis of Europe: for a long time, surveillance and supervision of the advanced economies was largely ignored, then suddenly they built up high budget deficits and accumulated too much government debt, producing a sovereign debt crisis which has also caused systemic risk.
A third example concerns global liquidity and capital flows. And if we provide too much liquidity globally, we
risk triggering abrupt capital flows in or out, which can be dangerous. Some say that liquidity is a term that’s not defined clearly enough. Roughly speaking, global liquidity, as the term is used in IMF and Bank for International Settlements (BIS) research papers, refers to the total supply of the main reserve currencies. Global liquidity has two dimensions: one is the quantity of the money supply; the other is the price, e.g. the interest rate. If the quantity of supply is very large while the interest rate is very low, it means there is abundant liquidity globally. The fourth vulnerable point concerns imbalances. We know that the accumulation of a trade surplus, the accumulation of a trade deficit, can produce dangerous external imbalances. If we can identify these vulnerable points, we can focus our surveillance to prevent a crisis from happening. But this is difficult: sometimes there is a focus on one dimension combined with a neglect of other dimensions that can then produce instability. For example, in 2008 and 2009 the sovereign debt crisis occurred. With institutions like the International Monetary Fund, the capacity of surveillance is limited. It is impossible for surveillance to detect every vulnerability, every time, so we have hard choices.
In my third remark, I will comment briefly on broadening the SDR basket. Broadening the SDR basket is a good idea but we also have to look closely at the two IMF on this:
1) the basket of currencies should consist of the largest exporters. (This means that trade, especially export, is the most important consideration for currency to be in the basket), and 2) the currency should be freely usable. Keep in mind that the IMF is not using the term »fully convertible,«but »freely usable« which means that it’s freely usable for payments, settlements of trade and maybe some Foreign Direct Investment (FDI) transactions. The obvious candidates among the currencies are the BRICS countries. We should look to both the BRICS countries and the IMF for criteria. For most of the BRICS countries, the first criterion—export—is already satisfied, but the second criterion is rather weak. But a lot of countries are working on it and there has been rapid improvement.
If we put the BRICS countries into the present SDR basket, or even if we consider more countries to make up the SDR basket, we find that the new basket would decrease the volatility of the present basket in terms of variance and standard deviation. The broader basket would also have better representation, which reflects world economic fundamentals. I think in terms of commodity trade and export, and in terms of the valuation and the resilience of the SDR, this would be beneficial. I know that it takes time and we have to follow
the rules. There is no hurry, but I suggest to IMF, we’re starting to calculate. We shadow the SDR, which means that the IMF should calculate the simulation by using data so that we can accumulate statistics and evidence to inform future discussions and consideration of this issue.
On the improvement and reform of international monetary system, I would like to make three points.
First, what is a good international monetary system? If we want to make reforms and improvements to the
international monetary system, they must promote the characteristics that such a system should have. I suggest the following seven characteristics of a good international monetary system:
1) It should promote development, which means that the system can facilitate trade and investment.
2) It should provide correct incentives for those who work hard, so their efforts can pay-off. This means,
whether the country is big or small, and regardless of its region or religious makeup, et cetera, it should provide the right incentives.
3) It should be able to do the adjustment when the balance of payment is imbalanced. International history
suggests that countries compete for different reasons,some based on mercantilism (and a positive balance of
trade) others to make their money cheap. The system should be able to provide a mechanism to adjust each of these kinds of imbalances.
4) It should be able to provide a safety net so that during a crisis it can provide the necessary liquidity to deal
with the crisis.
5) It should have an accurate representation of the world and reflect the world economic fundamentals.
6) It should be stable and resilient against all kinds of shocks—economic, political and otherwise.
7) It should contribute to maintain the stability of exchange rates and effective regional arrangements.
If we consider human history for the last 100 or more years, we have experienced the gold standard, the Bretton Woods system and also the post-Bretton Woods (Jamaica Accord). Each of these different versions of the international monetary system can address some problems better than others. A desirable system should find an efficient balance between the strengths and weaknesses of the various systems.
The second remark I want to make is that if we know what a good international monetary system should look like, the next step is deciding how to reform the current international monetary system accordingly. Before we answer that question we have to ask, »What are the vulnerable points, the shortcomings of the current system?
We need to focus our surveillance on those points in order to prevent another crisis. The Lehman Brothers
crisis of 2008 shows that a lack of financial supervision is a vulnerable point that can trigger systemic risk.
Another example is the sovereign debt crisis of Europe: for a long time, surveillance and supervision of the advanced economies was largely ignored, then suddenly they built up high budget deficits and accumulated too much government debt, producing a sovereign debt crisis which has also caused systemic risk.
A third example concerns global liquidity and capital flows. And if we provide too much liquidity globally, we
risk triggering abrupt capital flows in or out, which can be dangerous. Some say that liquidity is a term that’s not defined clearly enough. Roughly speaking, global liquidity, as the term is used in IMF and Bank for International Settlements (BIS) research papers, refers to the total supply of the main reserve currencies. Global liquidity has two dimensions: one is the quantity of the money supply; the other is the price, e.g. the interest rate. If the quantity of supply is very large while the interest rate is very low, it means there is abundant liquidity globally. The fourth vulnerable point concerns imbalances. We know that the accumulation of a trade surplus, the accumulation of a trade deficit, can produce dangerous external imbalances. If we can identify these vulnerable points, we can focus our surveillance to prevent a crisis from happening. But this is difficult: sometimes there is a focus on one dimension combined with a neglect of other dimensions that can then produce instability. For example, in 2008 and 2009 the sovereign debt crisis occurred. With institutions like the International Monetary Fund, the capacity of surveillance is limited. It is impossible for surveillance to detect every vulnerability, every time, so we have hard choices.
In my third remark, I will comment briefly on broadening the SDR basket. Broadening the SDR basket is a good idea but we also have to look closely at the two IMF on this:
1) the basket of currencies should consist of the largest exporters. (This means that trade, especially export, is the most important consideration for currency to be in the basket), and 2) the currency should be freely usable. Keep in mind that the IMF is not using the term »fully convertible,«but »freely usable« which means that it’s freely usable for payments, settlements of trade and maybe some Foreign Direct Investment (FDI) transactions. The obvious candidates among the currencies are the BRICS countries. We should look to both the BRICS countries and the IMF for criteria. For most of the BRICS countries, the first criterion—export—is already satisfied, but the second criterion is rather weak. But a lot of countries are working on it and there has been rapid improvement.
If we put the BRICS countries into the present SDR basket, or even if we consider more countries to make up the SDR basket, we find that the new basket would decrease the volatility of the present basket in terms of variance and standard deviation. The broader basket would also have better representation, which reflects world economic fundamentals. I think in terms of commodity trade and export, and in terms of the valuation and the resilience of the SDR, this would be beneficial. I know that it takes time and we have to follow
the rules. There is no hurry, but I suggest to IMF, we’re starting to calculate. We shadow the SDR, which means that the IMF should calculate the simulation by using data so that we can accumulate statistics and evidence to inform future discussions and consideration of this issue.
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