On March 23, Zhou Xiaochuan, the governor of the People’s Bank of China, published a text titled “Thoughts on the Reform of the International Currency System,” which proposes that “the rapid spread of the financial crisis to a global scale reflects the intrinsic defects and systemic risk of the current international monetary system.” He stresses that creating a currency decoupled from sovereign nations and able to maintain stable, long-term currency values is the ideal goal of reforming the international currency system. Such a currency would avoid the intrinsic defects of sovereign “fiat” currency acting as reserve currency.
Over the past few days, Zhou’s suggestions have provoked intense discussion among government officials and investors in many countries, but overall, most Western countries are utterly unenthusiastic about putting this idea into practice. On March 24th, President Obama said, “I don’t believe there’s a need to establish a global currency." On the same day, in a Congressional hearing, U.S. Treasury Secretary Geithner and Federal Reserve Chairman Bernanke were asked whether or not they were “resolutely opposed to a shift away from the dollar to some kind of global currency.” Both men said that they were. The IMF’s managing director, Dominique Strauss-Kahn, said in Paris, “I think a conversation over a new type of international reserve currency would be completely reasonable; perhaps discussions will be carried out in the next few months." The U.N.’s economic and financial advisory mission will submit a report to the general assembly in 26 days, urging world leaders to agree to the construction of a new international currency system as an alternative to the U.S. dollar. The leaders of Russia, Brazil and other countries have declared that this advice is worthy of a complete discussion.
China International Finance Corporation’s chief economist, Ha Jiming, thinks that establishing a “super” currency to replace the dollar as the international reserve currency could increase the stability and credibility of international reserves, and also would be a kind of release for the U.S. Using the currencies of major countries to constitute the “super” currency would be the best choice for an international reserve asset.
Ha predicts that if the reforms can be realized, China’s position in international currency and financial markets will rise, internationalization of China’s Renminbi (RMB) will accelerate, and the RMB will likely appreciate in the long-term. These changes will have deep implications for China’s economy and capital market.
In his opinion, Zhou Xiaochuan’s initiative follows the thinking of the Keynesian era. He recalls the origins of thinking about international reserve assets. In the early 1940s, Keynes had previously proposed the establishment of an international clearing union and the creation of a new currency (the "bancor"), independent from the control of any nation, which would provide liquidity to the world. But after World War II, the Bretton Woods Agreement that established the IMF did not adopt Keynes’ proposal, but instead adopted U.S. Treasury official Harry Dexter White’s exchange rate scheme, one that pegged the dollar to gold, with all other currencies pegged to the dollar. Consequently, the dollar became an important international reserve currency.
But at the start of the 1970s, following the decoupling of the dollar from gold, the U.S. still enjoyed the great benefit of seigneurage over the international reserve currency. However, with other countries’ currencies still pegged to the dollar, the U.S. found itself at a disadvantage of its own: It was difficult to adjust its balance of payments through devaluation while adjusting the cost of excessive external imbalances through domestic price changes and fluctuations in the real economy.
Ha Jiming says the rules of the international monetary system impact payments, financing instruments and institutional security. The international monetary system could be organized according to a system of fluctuating exchange rates or a set of international reserve assets. Depending on the mechanism by which exchange rates are formed, the range of fluctuation can be determined through fixed exchanged rates, adjustable pegs, floating pegs, crawling pegs, a managed float or completely free-floating exchange rates. According to the distribution of reserve assets, you could have a gold standard (gold as the only international reserve asset), a credit-money system (based on dollars, for example) or a combination of these two.
In reality, the international monetary system often combines these two different methods of classification. For example, the gold standard is a fixed exchange-rate system; the Bretton-Woods system was a combination of fixed exchange rates and gold-backed dollar reserves; the present international monetary system is based on floating, but managed, exchange rates, along with U.S. dollar reserves decoupled from gold. Of course, under completely free-floating exchange rates, reserve assets would become unnecessary, because imbalances in the international balance of payments could be corrected automatically through exchange rate adjustments. In other words, the greater the flexibility of exchange rates, the smaller the demands on foreign reserves.
Ha suggests that a good international monetary system should be beneficial to promoting international trade and investment, as well as distributing the "dividends’" of economic globalization fairly among countries. The advantages (and disadvantages) of an international monetary system can be judged in terms of three aspects: adjustment, mobility and credibility. Adjustment refers to the correction mechanism for international payment imbalances. A good international monetary system should be capable of correcting imbalances at the lowest cost and the highest speed. Mobility has to do with whether international reserve assets are enough to settle imbalances in international payments. A good international monetary system should be capable of providing appropriate reserve assets, correcting payment imbalances so as not to introduce global deflation or inflation. Credibility refers to the efficiency of the correction mechanism along with the security of international reserves.
Ha Jiming thinks that managed floating exchange rates are the most viable exchange rate scheme at present, and that the world cannot realize a completely free-floating exchange rate mechanism. The reasons are, first, that excessive currency fluctuation along with international trade leads to excessive speculation. Secondly, beggar-thy-neighbor policies – competitive devaluation and trade protectionism – become more prevalent. During the two world wars, a short-lived attempt at a floating exchange rate ended in failure. On the other hand, under a system of fixed exchange rates, countries lose their independence on monetary policy and are forced to correct imbalances in international payments and in the real economy by implementing price fluctuations, all at too great a cost.
How can mobility and adjustment – two important aspects of a good international monetary system – be achieved? First, Ha Jiming thinks a New Special Drawing Right (NSDR) would include, apart from the four main currencies (the dollar, the euro, the yen and the pound), the currencies of other major countries – the RMB among them. Next, the IMF should distribute NSDRs among a large number of member nations, allowing them to become the currency of international settlements, as well as the basis of each country’s monetary and exchange rate policies. Each country could, through borrowing NSDRs from the IMF, settle its temporary balance of payments problems. Countries with surpluses will lend NSDRs to deficit countries through the IMF, with interest rates set by supply and demand, or by referring to average interest rates in the countries whose currencies back the NSDR; deficit countries’ lack of NSDRs will push their exchange rates up (or implement contractionary monetary policy) and surplus nations will experience lower exchange rates (or implement expansionary monetary policy). The IMF could periodically set the total amount of NSDRs to maintain an appropriate level of global liquidity.
But Ha Jiming also warns that these important reforms are difficult to accomplish overnight. America’s willingness to give up the dollar’s special status as international reserve currency, the design and scale of the new reserve currency, along with questions of distribution and so on: In addition to technical details, these questions are related to each country’s choices over its interests and responsibilities.