Cao Tong: Four Suggestions on Global Monetary Governance-By Caotong

2015-07-09 IMI

Cao Tong: Co-Director and Council Member of IMI; President of WeBank Seventy years ago, representatives from 44 countries, including the United States and the United Kingdom, met in Bretton Woods, New Hampshire in 1944 for the United Nations Monetary and Financial Conference, during which, the final act was adopted based on "White's Plan". It was decided that two international financial institutions should be established, namely, the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD) .The double-peg international monetary system with the US dollar at the center was officially launched, linking the dollar to gold at the rate of $35 per ounce of gold and pegging other countries' currencies to the dollar. Undoubtedly, the Bretton Woods system has proved its far-reaching significance, as it played an important role in promoting post-War international financial stability and advancing post-War economic recovery. Firstly, the Bretton Woods system put an end to the pre-war chaotic situation in the international monetary and financial field and returned the post-War international monetary system to normality. Following World War One, with severe inflation in various countries, the free convertibility and transfer of gold got stuck and the gold standard was abolished. The world economic crisis during 1930s accelerated the collapse of the gold standard and the international monetary and financial system lost the unified institutional basis. Countries formed competing currency blocs, tightened foreign exchange controls and engaged in foreign exchange dumping, thus plunging the international monetary and financial system into complete chaos. However, with the establishment of the dollar-centered Bretton Woods system after World War Two, the international monetary and financial institutions regained a unified basis, with the US dollar being the major international reserve currency, making up for inadequate international liquidity in the post-War world and, to a large extent, easing the shortage of international reserves due to undersupply of gold. Secondly, the Bretton Woods system effectively boosted international trade. Building on its gold reserves, the United States issued huge amounts of dollars by way of providing grants and credit and buying foreign goods and labor services, thus laying the currency basis for international trade. At the same time, the fixed foreign exchange rate has, to some extent, reduced the risks of exchange rate volatility, stabilized the exchange rates of the currencies of major countries and promoted smooth international trade activities. Thirdly, after the Bretton Woods system was established, the IMF and the World Bank played a positive role at certain level in the global economic recovery and development. After the World War Two, many countries, restrained by limited gold and foreign exchange reserves, resorted to currency depreciation, resulting in balance of international payment crises. The loans provided by the IMF eased these problems to different degrees. As its lending operations continued to expand, the IMF shifted priority from Europe to the third world countries in Asia, Africa and Latin America to support the development of these countries. Long-term loans and investment from the World Bank met the financial needs of countries to varying extent in their post-war recovery and reconstruction efforts. The World Bank also gradually made loans available to developing countries in order to meet their funding demands. The IMF and the World Bank also played a positive role in technical assistance provision, global macro economic monitoring, international economic and monetary research, poverty reduction, and removal of development bottlenecks. However, the flaws inherent in the Bretton Woods system were gradually exposed over time, mainly manifested in the lack of stability associated with an international monetary system dominated by the currency of one country (the US dollar). In the past decades, the growth of global economy and trade demanded more support of the foreign exchange reserves, which could only be solved by long-term trade deficit of the United States; Meanwhile, the US dollar had to be stable and strong to remain as the core international currency, which required the United States maintain trade surplus or a balance of international payments. These two conflicting aspects have caused the "Triffin Dilemma". As we have seen, the US dollar went through several crises in the following years. In August 1971, the United States announced to suspend selling gold to other countries, severing the linking between the the US dollar and gold. During the US dollar crisis in 1973, the United States once again declared depreciation of the US dollar, leading to the adoption of the "floating exchange rate" in place of the "fixed exchange rate" by various countries. By signing the Jamaica Agreement in 1976, the Bretton Woods system in the traditional sense ceased to exist, and the world entered the era of "Jamaica Agreement". The Jamaica Agreement, which recognizes the natural evolution of the monetary system, is a "system without system". But because of the irreplaceable status of the US economy and the US dollar, the global monetary system continues to be dominated by US dollar, only that the US dollar is no longer pegged to gold, showing the salient feature of a "Greenback standard". The time between 1976 and the 2008 financial crisis was an unprecedented era of "explosion" of global money creation and financial innovation. This era of "explosion" saw the cropping up of the floating exchange rate, unrestricted capital flows, excess credit supply and innovative financial instruments, repeatedly shattering traditional financial concepts. After the latest financial crisis，we saw massive quantitative easing for rescuing purpose, central banks purchasing large quantities of equities and debts of commercial entities with base currency, monetization of government debts in large scales, and prolonged measures to intervene in and suppress market interest rates. With these developments, the concept of the global monetary governance entered a period of "concept without concept" . Today as we commemorate the 70th anniversary of the Bretton Woods system, we are in fact marking two 30-year-long monetary eras, divided by the transition of the double-peg international monetary system to a single-peg one. Although both systems regard the US dollar as the core currency, they are very different. The repeated occurrence of financial crises across the globe since the 1970s were caused fundamentally by following reasons: First, unrestricted money creation leads to the expansion of visual finance. Second, as the international base currency, the issuance of US dollar faces no restrictions except for moral injunction imposed by itself. And third, when its domestic monetary policy clashes with the global monetary policy, the United States will certainly choose to protect itself. The 2008 global financial crisis was caused by these fundamental factors. Moving forward to the next 30 years, how should we design the course for the global monetary system? How to strike a balance between preservation and innovation of the global monetary governance? In this context, I would like to make the following four proposals: First, we should develop a "tripartite" international currency standard system. The flaws of the single currency system dominated by the dollar are obvious. If the system is not reformed, the next financial crisis will be just around the corner, and it will be even more disastrous for the global economy. A diversified currency standard system can play a positive role in stabilizing global exchange rates, supervising the fulfilment of responsibilities by the issuing countries of standard currencies, and reducing the amount of money created by central banks. Considering the economic size of different countries and the representation of their currencies, a "tripartite" currency standard system consisting of the dollar, the euro and the Renminbi would be the best option. The three currencies shall be accepted by all countries as both reserve currencies and pricing currencies for commodities and the financial market. In the meantime, these three economies shall also exercise their duties as the issuers of base currency. Second, we should develop a "core-peripheral" flexible exchange rate regime at the global level. In order to improve the stability of the global exchange rate structure. there should be relatively fixed exchange rates among the tripartite core currencies, while the peripheral currencies shall keep their existing floating exchange rate regimes Third, we should develop common global rules for money creation. We live in a globalized world with floating exchange rates and free cross-border capital flows. The money created by every individual country shall also be seen as money created for the whole world, and they all make a profound impact on the global economy. Given time, the monetary policies adopted by individual countries could all cause spillover effects in other parts of the world. Therefore, just as in the case of carbon emissions, countries in the world should try to develop a "global covenant on money creation" to put a check on the creation of money as well as unregulated quantitative easing and government debt monetization. Only in this way can we ensure that we will not be suffocated by the "CO2" emitted in the form of money. Fourth, we should develop a new global structure and mechanism for monetary governance. The global political and economic landscape has changed a lot over the past 70 years, and the role of the IMF and the World Bank in global monetary governance is significantly reduced. Both their functions, representation and decision-making mechanisms are increasingly misaligned with the demand of monetary governance in the new era. Therefore, countries should establish a new monetary governance structure and mechanism within the G20 framework to meet the demands of the new world. The financial crisis that started in 2008 is not completed, yet the factors that triggered the crisis are surfacing and becoming active again. In particular, the excessive money supply caused the crisis in the first place, but countries have been attempting to bail out with the creation of even more money. Where and when is the cycle going to end? There are many lessons we can learn from the evolution of the Bretton Woods system and the Jamaica monetary system over the past 70 years. The global monetary governance system is never static. While keeping its fundamental principles, it is constantly moving forward through innovation, responding to the new demands of global politics and economy, and making important structural changes at critical moments in history. All the members of the international financial community, must seize the historical opportunities, and work together to build up a new global monetary governance system.

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Cao Tong: Four Suggestions on Global Monetary Governance-By Caotong

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