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Monetary challenges in a multipolar world

Can international monetary reform succeed?

By Jean Pisani-Ferry

13 September 2011

The reform of the international monetary system has been selected by the French presidency of the G20 asits main priority for the Cannes summit in November. This raises two questions: First, is the issue worth thetime and energy officials will devote to it? Second what can these discussions lead to?

When French President Nicolas Sarkozy announced his aim a year ago, most observers expected that at

end of 2011 the world economy would be cruising at a comfortable speed. The macroeconomy would, so tospeak, be taking care of itself. At the same time, the budding controversies about "currency wars"suggested that the international monetary discussion was a very necessary one. One year on,unfortunately, other urgent matters called for public attention: with the flagging global recovery and themounting debt crisis on everybody's mind, the subject of longer-term monetary reform now seems like adistant distraction.

A case can, however, be made for keeping discussions on the issue active. Indeed, several of the economicfailings of recent years can be traced back to the global monetary system.

Excess global liquidity, the over accumulation of dollar-denominated reserve assets, the very uneven policyresponse to current-account surpluses and deficits, resistance to necessary exchange-rate adjustments inthe emerging world and the coexistence at the global level of inflation and deflation, to name but a fewrecent phenomena, are all in some way manifestations of the same international monetary deficiencies.Addressing these deficiencies would perhaps not solve today's economic woes, but it would help limit thebuild-up of new problems and it would provide guidance as regards the avenues for alleviating today'sconcerns.

This is where the second question comes in. France has paradoxically been cautious neither to make clearwhich problems global monetary reform is expected to solve, nor to propose a grand plan for it. Rather, ithas taken topics one by one and has sought to reach consensus separately on each individual dossier.

Discussions within the G20 are evolving around the completion of efforts undertaken by the 2010 Koreanpresidency to strengthen multilateral schemes for liquidity provision in times of crisis; the strengthening ofmultilateral surveillance and the search for consensus on the desirable use of capital controls; andpreparations for a change in the composition of the basket of Special Drawing Rights, a unit of account usedby the IMF that was at its origin expected to evolve into a global store of value.

This piecemeal approach is politically savvy but analytically perplexing, as it does not give any clues as tothe big picture. The dots are there, but it is hard to see how to connect them. Since the internationalmonetary system has experienced few changes in historical terms, efforts to revamp the system shouldrather be considered as small steps in what is bound to be a long march. Whether small steps areappropriate should be assessed in light of a longer-run perspective covering at least the next ten to fifteen

years.

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The most probable scenario at this horizon is a multipolar one that would see, in addition to the US dollar,the emergence of one or several key international currencies. For this role, the euro and the yuan can be

viewed as prime candidates. Each currently has severe shortcomings and it cannot be excluded that onlyone of these currencies accedes international currency status nor that other currencies emerge, thoughat a significantly longer-term horizon. But the economic logic is unambiguously in the direction ofmultipolarity.

The evolution of the international monetary system could develop with a liquid market for benchmarkbonds to allow for free capital mobility and exchange-rate flexibility between the different poles. Thestability of a genuinely multipolar system cannot be taken for granted, and will require countries to departfrom purely domestic priorities in quiet times as well as in times of crisis.

Such preconditions are clearly not met today by the main economic and currency blocs, albeit for different

reasons. China has already taken significant but incomplete steps in the direction of currencyinternationalization. Furthermore its policy system remains very domestically centered. The euro area iscurrently under severe stress. It could possibly strengthen as a consequence of its current crisis, but toplay a significant international role it will have to depart from its traditionally neutral stance towards theinternationalization of the currency. And as far as the United States is concerned, it is not yet willing toaccept full responsibility for the international repercussions of its macroeconomic actions.

If the international monetary system is actually moving towards multipolarity in the medium run, the roleof international coordination is to accompany this market-based movement so as to reap the full benefitsof it and attenuate the risks involved. The discussions surrounding the enlargement of the SDR basket(through the inclusion of the yuan) and the coordination of bilateral swap arrangements should beunderstood in this perspective.

Does this exclude a multilateral system organized around a quasi-global currency and the centralisedmanagement of global liquidity? In the short run, the conditions for this scenario to materialise are not met,not least because no large country is ready to deviate from domestic priorities. In the future, however, sucha scenario might return to the fore, for instance in the event of another global crisis. A truly multilateralsystem remains a possible outcome, but not the most likely one.

These broad perspectives are not likely to be discussed in Cannes. This is perhaps unavoidable, becausethe leaders have to focus on what they can actually deliver. At the same time, it would be much preferableto leave the technicalities of the SDR basket and liquidity provision schemes to the finance ministers, andto let the heads of state and government discuss the issue for which they are indispensable: the politics ofglobal currency reform.