by Juan Pablo Painceira
The size and spread of present financial crisis has shown to analysts and public alike how important the dynamic of world money is to the global economy. Surely this crisis would not have the same magnitude if the heart of crisis was not the US economy, the issuer of world money. The importance of international money in the unfolding of financial crisis was addresses by this author in an earlier RMF discussion paper (http://www.soas.ac.uk/rmf/papers/).
It is well know that the Federal Reserve has taken conventional and extraordinary measures to tackle the 2007-08 financial crisis in order to rescue/recover the financial system’s ability to perform their normal functions, and in particular banks,. Among the FED’s measures, the swap currency lines, initially offered to the major central banks and extended to the key developing countries after September 2008, are directly related to the role of dollar as world money. Basically, the Federal Reserve has offered credit lines in dollars around the global economy.
The spread of those swap lines and the monetisation of US public debt have raised questions about the functionality and stability of international money, ie the US dollar. Recently, the China’s central bank chief and the Russian government have proposed a bigger role for the IMF’s SDR in global financial operations in order to achieve a supra-national reserve currency to replace the dollar as world money. The Special Drawing Rights (SDR) created by IMF in the 1970s is a basket of major currencies traded in the international financial and commercial operations. The value of SDRs daily is determined by summing, in US dollars, the values of a weighted basket of currencies and used as monetary reference to the IMF’s operations. So, the SDR are reserve assets.
The emergence of new world money and the reform of international financial system has been widely discussed in the last weeks e.g. G. Soros addressed the need for the IMF to take care of some developing countries external financing immediately in order to avoid a Great Depression; the increase of issuance of SDR would be the instrument to use. Some analysts are arguing that a new global reserve currency would lead also to changes in the process of reserve accumulation and exchange rate regimes among the major countries. A UN commission lead by J. Stiglitz advocates that to deal properly with the consequences of global imbalances it is necessary to have a new global reserve system based on the expansion of the SDR.
It seems that this new world money would lead a more stable and equitable global financial system.
However, some questions are still remained…Would China be really interested in walking away from dollar denomination, considering that its foreign exchange portfolio is highly concentrated in dollar? The same question could be asked for Japan. If the IMF becomes the global lender of last resort, who would be the Treasury of last resort? Who will control the political decisions to lend or not lend? I recognise that those questions are hard but we know from the economic history that a change in the global monetary standard can be painful and that effects can last many years as did the change from the gold standard to the dollar-gold standard. Lastly, a currency has a political force behind it, even when it is a supra-national currency, are the conditions ripe for the IMF / World Bank to take on such a role?