The conditions presently surrounding the global monetary system has been due to specific non economic decisions taken. Prior to recession, attention was focussed on massive global imbalances. These imbalances were due to accumulation of foreign exchange reserves in developing economies. When crisis erupted, the attention was focussed on the development of large liquidity in international sense along with counter-cyclical macroeconomic policies.
With the collapse of dollar-gold exchange standard, the policy makers developed a fiduciary US dollar as means of payment and a major form of foreign exchange reserve. With the development of international trade, currencies of major economies would only compete with the fiduciary currency as a means of payments in international market.
With the outset of Bretton Woods and the onset of globalization, the focus shifted on developing countries which were subject to strong pro-cyclical swings. These swings were capable to generate significant macroeconomic risks. In absence of IMF and other prime lenders the international trade generated precautionary demand for foreign exchange reserves making it mandatory for developing economies to park reserves. The other reason being the outset in 1980s of Latin America and the Asian Crisis in 1997. Both were forecasted to be due to credit crunch and loose policies in developing markets.
Hence we can understand these to be pro-cyclic in nature but also counter cyclic in working. This self protectionist environment has lead to many imbalances including deregulation and free fall of commodity market. All this was attributed to the Financialization in the developing economies. Such mechanics in the market have created unstable and discriminated global reserve system. The developing nations always preferred to keep their currency depressed in order to advance their exports. This depreciation added to the implication of handling reserve which could only get the interest on bonds.
Keynes advocated an entirely different concept. Keynes advocated the development of an International Clearing Union. The requirement was stated as in order to regain stability, the whole world and its economies have to come on a single focal plane. For this all will have to have recurrent and similar in slope deficits or no deficits at all. This is required as the new Union would not be able to justify the currency movement unless the equality is present. But with the onset of Bretton Woods, the Keynes theory was rejected.
Along with Keynes another economist Triffin advocated against the Dollar domination. He stated and advocated the point that a National currency should never be the International currency in global market. Always the asset based currency is not the actual mode of trade, it is the asset liability pattern present in each economy. It can be elucidated that global imbalances are the major contributors of drag in international market as the currency is just an asset based provision to either clear all liabilities or any short term provisions. In such case having a national currency at epitome point may cause imbalance in internal as well as external environment. Policies, whether monetary or fiscal, may have an impact on entire global market and the external trade scenario as a whole.
In this case for US, initially with BOP in surplus can now enjoy a risk free deficit in their accounts. The deficit can be maintained until it is financed regularly. With the onset of recession the deficit to GDP grew substantially advocating the Triffin’s ideology.
Looking at the Recession of 2007-08, during growth phase, developing nations hovered into international market with a thrust for higher ratio of surplus reserves in their account. This development of reserve then in 2006 paved way to the demand of safe asset where the reserves can be implanted. This lead to increase in pressure on industrialist nations, like US. This lead to overvaluation of certain assets and high undervaluation of some leading to imbalance and thus shaking the balance of payments globally.
In order to overcome from such problems, Triffin’s theory needs to be implemented. The theory demands an independent international currency with a governing clearing union. But the hurdle which remains here is the allocation of the currency with respect to the reserves. In this process Inflation internal and external has to brought to similar levels and the surplus have to valued at a similar rating. For all these to be true there will be a requirement of massive restructuring in lines with the Keynes notion and his theories. The impact this restructuring will have can be harmonious or it can affect the international trade heavily.
Another method can be float of multi-currency hierarchy. This may mean a secondary market for all the currencies and the primary market for the national currency and the currency with which the trade is to be initiated. This may reduce floating exchange risks but may add to arbitrage positions leading to under and over valuation of assets in a single entity but in different currencies.
Another can be the use of SDRs as the global reserve currency as advocated by the former Chinese Premier. With SDR the allocation would become easy and fair as it is a combination of 4 different basket currencies hence any upside or downside risk gets easily mitigated. On the other side the same inflationary concern and the inequity bias may erupt in case of high reserve and low inflation economies like China and a ,moderate reserve and high inflation economies like India.
- Vinit Thanvi
