Special Report: Global Financial Crisis
By Zhou Xiaochuan
BEIJING, March 26 -- The outbreak of the current crisis and its spillover
in the world have confronted us with a long-existing but still unanswered
question,i.e., what kind of international reserve currency do we need to secure
global financial stability and facilitate world economic growth, which was one
of the purposes for establishing the IMF? There were various institutional
arrangements in an attempt to find a solution, including the Silver Standard,
the Gold Standard, the Gold Exchange Standard and the Bretton Woods system. The
above question, however, as the ongoing financial crisis demonstrates, is far
from being solved, and has become even more severe due to the inherent
weaknesses of the current international monetary system.
Theoretically, an international reserve currency
should first be anchored to a stable benchmark and issued according to a clear
set of rules, therefore to ensure orderly supply; second, its supply should be
flexible enough to allow timely adjustment according to the changing demand;
third, such adjustments should be disconnected from economic conditions and
sovereign interests of any single country. The acceptance of credit-based
national currencies as major international reserve currencies, as is the case in
the current system, is a rare special case in history. The crisis again calls
for creative reform of the existing international monetary system towards an
international reserve currency with a stable value, rule-based issuance and
manageable supply, so as to achieve the objective of safeguarding global
economic and financial stability.
I. The outbreak of the
crisis and its spillover to the entire world reflect the inherent
vulnerabilities and systemic risks in the existing international monetary
Issuing countries of reserve currencies are
constantly confronted with the dilemma between achieving their domestic monetary
policy goals and meeting other countries' demand for reserve currencies. On the
one hand,the monetary authorities cannot simply focus on domestic goals without
carrying out their international responsibilities??on the other hand,they cannot
pursue different domestic and international objectives at the same time. They
may either fail to adequately meet the demand of a growing global economy for
liquidity as they try to ease inflation pressures at home, or create excess
liquidity in the global markets by overly stimulating domestic demand. The
Triffin Dilemma, i.e., the issuing countries of reserve currencies cannot
maintain the value of the reserve currencies while providing liquidity to the
world, still exists.
When a national currency is used in pricing primary
commodities, trade settlements and is adopted as a reserve currency globally,
efforts of the monetary authority issuing such a currency to address its
economic imbalances by adjusting exchange rate would be made in vain, as its
currency serves as a benchmark for many other currencies. While benefiting from
a widely accepted reserve currency, the globalization also suffers from the
flaws of such a system. The frequency and increasing intensity of financial
crises following the collapse of the Bretton Woods system suggests the costs of
such a system to the world may have exceeded its benefits. The price is becoming
increasingly higher, not only for the users, but also for the issuers of the
reserve currencies. Although crisis may not necessarily be an intended result of
the issuing authorities, it is an inevitable outcome of the institutional flaws.
II. The desirable goal of
reforming the international monetary system, therefore, is to create an
international reserve currency that is disconnected from individual nations and
is able to remain stable in the long run, thus removing the inherent
deficiencies caused by using credit-based national currencies.
1. Though the super-sovereign reserve currency has
long since been proposed, yet no substantive progress has been achieved to date.
Back in the 1940s, Keynes had already proposed to introduce an international
currency unit named "Bancor", based on the value of 30 representative
commodities. Unfortunately, the proposal was not accepted. The collapse of the
Bretton Woods system, which was based on the White approach, indicates that the
Keynesian approach may have been more farsighted. The IMF also created the SDR
in 1969, when the defects of the Bretton Woods system initially emerged, to
mitigate the inherent risks sovereign reserve currencies caused. Yet, the role
of the SDR has not been put into full play due to limitations on its allocation
and the scope of its uses. However, it serves as the light in the tunnel for the
reform of the international monetary system.
2. A super-sovereign reserve currency not only
eliminates the inherent risks of credit-based sovereign currency, but also makes
it possible to manage global liquidity. A super-sovereign reserve currency
managed by a global institution could be used to both create and control the
global liquidity. And when a country's currency is no longer used as the
yardstick for global trade and as the benchmark for other currencies, the
exchange rate policy of the country would be far more effective in adjusting
economic imbalances. This will significantly reduce the risks of a future crisis
and enhance crisis management capability.
¡¡¡¡III. The reform should be guided by a grand
vision and begin with specific deliverables. It should be a gradual process that
yields win-win results for all.
The reestablishment of a new and widely accepted
reserve currency with a stable valuation benchmark may take a long time. The
creation of an international currency unit, based on the Keynesian proposal, is
a bold initiative that requires extraordinary political vision and courage. In
the short run, the international community, particularly the IMF, should at
least recognize and face up to the risks resulting from the existing system,
conduct regular monitoring and assessment and issue timely early warnings.
Special consideration should be given to giving the
SDR a greater role. The SDR has the features and potential to act as a
super-sovereign reserve currency. Moreover, an increase in SDR allocation would
help the Fund address its resources problem and the difficulties in the voice
and representation reform. Therefore, efforts should be made to push forward a
SDR allocation. This will require political cooperation among member countries.
Specifically, the Fourth Amendment to the Articles of Agreement and relevant
resolution on SDR allocation proposed in 1997 should be approved as soon as
possible so that members joined the Fund after 1981 could also share the
benefits of the SDR. On the basis of this, considerations could be given to
further increase SDR allocation.
The scope of using the SDR should be broadened, so as
to enable it to fully satisfy the member countries' demand for a reserve
Set up a settlement system between the SDR and other
currencies. Therefore, the SDR, which is now only used between governments and
international institutions, could become a widely accepted means of payment in
international trade and financial transactions.
Actively promote the use of the SDR in international
trade, commodities pricing, investment and corporate book-keeping. This will
help enhance the role of the SDR, and will effectively reduce the fluctuation of
prices of assets denominated in national currencies and related risks.
Create financial assets denominated in the SDR to
increase its appeal. The introduction of SDR-denominated securities, which is
being studied by the IMF, will be a good start.
Further improve the valuation and allocation of the
SDR. The basket of currencies forming the basis for SDR valuation should be
expanded to include currencies of all major economies, and the GDP may also be
included as a weight. The allocation of the SDR can be shifted from a purely
calculation-based system to a system backed by real assets, such as a reserve
pool, to further boost market confidence in its value.
IV. Entrusting part of
the member countries' reserve to the centralized management of the IMF will not
only enhance the international community's ability to address the crisis and
maintain the stability of the international monetary and financial system, but
also significantly strengthen the role of the SDR.
1. Compared with separate management of reserves by
individual countries, the centralized management of part of the global reserve
by a trustworthy international institution with a reasonable return to encourage
participation will be more effective in deterring speculation and stabilizing
financial markets. The participating countries can also save some reserve for
domestic development and economic growth. With its universal membership, its
unique mandate of maintaining monetary and financial stability, and as an
international "supervisor" on the macroeconomic policies of its member
countries, the IMF, equipped with its expertise, is endowed with a natural
advantage to act as the manager of its member countries' reserves.
2. The centralized management of its member
countries' reserves by the Fund will be an effective measure to promote a
greater role of the SDR as a reserve currency. To achieve this, the IMF can set
up an open-ended SDR-denominated fund based on the market practice, allowing
subscription and redemption in the existing reserve currencies by various
investors as desired. This arrangement will not only promote the development of
SDR-denominated assets, but will also partially allow management of the
liquidity in the form of the existing reserve currencies. It can even lay a
foundation for increasing SDR allocation to gradually replace existing reserve
currencies with the SDR.