SEOUL, Nov 9 (Reuters) - World Bank President Robert Zoellick has stirred a hornet’s nest with his proposal for a new “co-operative” monetary system, with a role for the yuan, that might refer to gold to gauge market expectations of inflation.
Following are the answers to some questions raised by Zoellick’s far-reaching suggestions.
Discontent over erratic currency swings has intensified since the global financial crisis, which dealt the greatest shock to the world economy since the collapse of the Bretton Woods regime of fixed but adjustable exchange rates in 1971.
Some academics foresee ever-greater volatility, making the search for a more stable system all the more urgent. Zoellick is adding spice to this debate.
Robert Aliber, professor of international economics and finance at the University of Chicago, said in an email that Zoellick was to be applauded for taking the initiative to reduce instability.
“The last forty years have been the most turbulent in monetary history. There have been four waves of financial crises; each wave has involved the failure of many of the banks and credit institutions in three, four or more countries at about the same time,” Aliber wrote in a new paper.
These failures, he said, have often been associated with abrupt slumps in exchange rates — something which runs counter to the assumption by proponents of free-floating currencies that adjustments to imbalances would be smooth and gradual.
“These large changes in currency values result from large changes in the scope and direction of cross-border movements of money; the reversal in the direction has led to very sharp depreciations of currency and has contributed significantly to domestic financial crises.
“The international monetary arrangements now are dysfunctional,” Aliber concludes.
Very much so.
France, which takes over the rotating chair of the Group of 20 major economies after this week’s Seoul summit, wants to make global monetary reform the centrepiece of its presidency.
One issue France wants to tackle is how the international system can protect countries from volatile fluctuations on the capital account of the sort Aliber describes.
New International Monetary Fund instruments, including the precautionary credit line and the flexible credit line, and South Korea’s suggestion of regional safety nets, go some way to addressing this problem.
A thornier issue, according to a French official, is diversification away from the dominance of the dollar. This was complicated for political reasons with the United States but also because it is not clear what the best alternative is.
Zoellick advocates a “co-operative monetary system” that is likely to need to involve the dollar, the euro, the yen, the pound and the yuan, also known as the renminbi.
That has echoes of an idea floated in March 2009 by Chinese central bank governor Zhou Xiaochuan, who suggested that the dollar could give way as the premier reserve currency to a beefed-up Special Drawing Right, the IMF’s unit of account.
Zhou did not say as much — he did not need to — but the yuan would be part of the SDR basket he had in mind.
“It would be not only a good thing for China, but good for the SDR because it would better reflect the structure of global trade and the economy,” said Ding Zhijie, a professor with the University of International Business and Economics in Beijing and an adviser to the Chinese government.
The Federal Reserve’s new policy of printing money to buy $600 billion of government bonds has raised widespread fears among emerging nations that Washington is trying to export its economic problems to the rest of the world via a weaker dollar.
“With the Fed’s quantitative easing, the dollar is losing its position as an anchor currency in the international monetary system,” Ding, the Beijing professor, said.
Zoellick put things differently, calling for the global monetary order to evolve in a way that “reflects emerging economic conditions” — code for the meteoric rise of the likes of China, India and Brazil.
A deal endorsed last Friday by the IMF’s executive board to shift six percent of voting power in the fund to such dynamic emerging economies fits into this mould.
On the foreign exchange front, the unfolding imperative is to carve out a bigger role for the yuan, the currency of the world’s second-largest economy but one that is not convertible on the capital account and so is barely used beyond China’s borders.
That could be about to change, though.
With China aggressively expanding use of the yuan for trade settlement, “a financial revolution of truly epic proportions” could be at hand, economists at HSBC said in a new report.
The Fed’s latest easing will surely only encourage governments, reserve managers, companies and individuals to think about alternatives to the dollar, they said.
“Given China’s heightened gravitational pull in the world economy, the renminbi is an increasingly credible rival. The world economy is, slowly but surely, moving from greenbacks to redbacks,” the HSBC economists said.
As Zoellick said, it takes time to develop a new monetary system.
One thing to watch is the composition of the SDR. The next review of the basket — now made up of the dollar, euro, yen and pound — is due to be completed in January.
Under present criteria, the yuan would not be eligible because it is not a convertible currency. But politicians can waive that rule and, in any case, the facts on the ground are changing as China permits yuan deposited outside China from trade settlement to flow back into the bond market.
Including the yuan in the SDR basket seems an obvious first step and is something the Chinese are ready to discuss, the French official said. But when, he asked? Next year? In a decade?
A more representative SDR should appeal to asset managers and, theoretically, transform it into a real currency.
But history has not been kind to synthetic currencies.
Only a few SDR bonds were issued and the appeal of the European Currency Unit — the precursor of the euro — was no match for the anchor of the European Monetary System, the mighty German mark.
Ultimately, many believe, the dollar will share its reserve status not with the SDR but with the euro and the yuan. But just how soon that might come about, and how, is unknowable.
“Governments may start talking about maintaining relative stability between major currencies, but it is still too soon to forecast what any new system will look like,” Ding, the Chinese professor, said. (Additional reporting by Zhou Xin; Editing by John Chalmers)