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THE COMING GLOBAL MONETARY DISORDER Benjamin J. Cohen University of California, Santa Barbara Remarks Prepared for presentation at the Fundación Rafael.

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Presentation on theme: "THE COMING GLOBAL MONETARY DISORDER Benjamin J. Cohen University of California, Santa Barbara Remarks Prepared for presentation at the Fundación Rafael."— Presentation transcript:

1 THE COMING GLOBAL MONETARY DISORDER Benjamin J. Cohen University of California, Santa Barbara Remarks Prepared for presentation at the Fundación Rafael del Pino, Madrid, Spain, 19 May 2014

2 EXECUTIVE SUMMARY Question: What is the outlook for the international monetary system (IMS)? Answer: More disorder (most likely scenario) Why? A growing sense of complacency, due to – ◦Overestimation of economic recovery ◦Underestimation of future risks What can we do? ◦Strengthen commitment to growth ◦Promote greater policy cooperation But can we do it?

3 CAVEAT Not everyone is complacent ◦IMF (“Global Agenda”, April): “The global recovery has strengthened but remains far from robust” ◦The Economist (May 10 th )warns that we “still face testing times” ◦Christine Lagarde (May 12 th ) warns of “deceiving calm” But the signs of growing complacency are evident ◦Capital is flowing back into European periphery; sovereign borrowing cost are dropping; spreads are narrowing ◦Ireland and Portugal have made a “clean exit” from their bail-outs, forgoing the safety net of a precautionary line of credit ◦Central banks are pulling back (US, UK) or standing pat (ECB)

4 THE GOOD NEWS The economic recovery is gaining strength ◦Latest forecasts (IMF): ◦World ◦USA ◦Euro area ◦Germany ◦France ◦Italy ◦Spain ◦United Kingdom ◦Japan ◦China

5 THE BAD NEWS Growth projections may be too optimistic Even if accurate, they are hardly impressive ◦Global growth is still well below potential ◦GDP in most advanced economies is still below 2008 ◦Unemployment is still very high ◦Threat of deflation (“lowflation”) ◦“Secular stagnation”? Worst: they underestimate three major dangers in the IMS ◦Exchange rate instability (“currency wars”?) ◦Peak currency competition (dollar crisis?) ◦Erosion of monetary cooperation (breakdown of governance?)

6 CURRENCY WARS? An old problem: temptation to manipulate exchange rates In principle, outlawed by IMF Article IV, “firm” surveillance In practice, surveillance is ineffectual; governments do what they want (“dirty floats”) ◦Direct intervention in the foreign-exchange market ◦Monetary policy (interest rates, money supply) ◦Capital controls

7 WHY IS SURVEILLANCE INEFFECTIVE? Motivations are difficult to assess: Is an ER movement the aim of policy or an incidental b- product? Examples: ◦US: Federal Reserve’s QE2 ◦Japan: “Abenomics” ◦China (and other Asian nations): reserve accumulations – insurance or ER manipulation? State sovereignty: IMF has little real authority to enforce the rules Result: danger of renewed currency war ◦Aggravated by sluggish recovery ◦In turn, retards recovery (inhibiting adjustment, increasing volatility and uncertainty )

8 DOLLAR CRISIS? Central role of the US dollar: good or bad? ◦Good: Stabilizing “hegemon” ◦Bad: Destabilizing monopolist (“exorbitant privilege”) ◦Answer: both (but more good than bad) Trend toward a multi-currency system: good or bad? ◦Good: Would impose discipline on the US ◦Bad: Would provoke competition, destabilizing shifts of confidence ◦Answer: again both (more bad than good) Real question: Are there any real challengers to the dollar? ◦Two possible candidates: euro and yuan (renminbi, RMB) ◦Answer: NO, BUT… ◦Neither is a threat to the dollar at the global level ◦But each will challenge at the regional level (an “asymmetrical multipolar system”) ◦Challenge will be sufficient to threaten greater instability

9 THE EURO Potential as an int’l currency remains unrealized. Why? Flawed from the start – an asymmetrical distribution of authority (monetary centralization, fiscal decentralization) – hence no credible mechanism to deal with internal payments problems Ideal solution: a “transfer union” (mutualization of risk) on model of US ◦Balanced budgets ◦Bail-out ban ◦Automatic transfers European “solution” – combination of ◦Fiscal limits (Stability and Growth Pact, now Fiscal Compact) ◦Bail-out ban, now European Stability Mechanism (ESM) ◦But NO automatic transfers Result: persistent crisis, anti-growth bias

10 ANTI-GROWTH BIAS Without automatic transfers, each imbalance crisis must be negotiated Adjustment pressures tend to fall on debtors ◦[Keynes: “the process of adjustment is compulsory for the debtor and voluntary for the creditor”] Only choice: “internal devaluation” (austerity) – hence an anti-growth bias In short, an updated version of the gold standard without gold – a “cross of euros.”

11 IS THE EURO DOOMED? Neither success nor failure ◦Centripetal force: commitment to union, fear of consequences of breakdown ◦Centrifugal force: imperatives of sovereignty ◦Result: an uneasy, untidy series of compromises, limiting the appeal of the euro as an alternative to the dollar Nevertheless, the euro will be a challenge to the dollar in its own neighborhood – a potentially destabilizing competition

12 THE YUAN A serious rival to the dollar? Clearly a Chinese goal China’s strategy (choice of goals) ◦Two tracks ◦Trade (swap agreements, trade invoicing) ◦Finance (bank and bond markets in Hong Kong) ◦Well conceived – stresses most important roles (trade, investment, reserves) China’s statecraft (choice of means) – less well conceived ◦Until now, reliance on China’s growing economic weight (“gravitational pull”) ◦Missing: financial development; rule of law ◦Why? Inconsistent with Chinese political economy model (“Beijing Consensus”) Conclusion: Will not be a serious threat to the dollar for a long time – but like the euro, will be a challenge to the dollar in China’s own neighborhood – a potentially destabilizing competition

13 GOVERNANCE Basic requirement: A minimum degree of policy cooperation; impossible without – ◦A consensus on basic principles ◦Effective leadership by dominant monetary powers ◦Neither seems evident today IMF ◦Promising reforms were agreed in 2010 ◦But implementation has been blocked by the US (specifically, Republicans) ◦Result: pressures by BRICS, others to move on without the US – IMF could split Group of 20 ◦Newly designated as the central locus of monetary governance ◦But few accomplishments ◦Reasons ◦Lack of consensus ◦Few have been willing to take the responsibility to lead ◦Result: drift, risk of rising policy conflict

14 CONCLUSION No reason to be complacent ◦Improvements have been overestimated ◦Risks are underestimated High risk of growing monetary disorder What can we do? ◦Strengthen commitment to growth ◦Promote greater policy cooperation Easier said than done Be prepared!


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