Ben Shenglin：Establishing Strategic Mutual Trust, Resolving the Dilemma of International Monetary System

2015-05-17 IMI

Ben Shenglin: Executive Director of International Monetary Institute, Renmin University of China and Professor of School of Management, Zhejiang University The current international monetary system is not sustainable The current international monetary system is confronting with the Prisoner’s Dilemma reflected in the following aspects: First, the current US dollar interest rate setting mechanism of the Fed is considered “unbalanced” andinconsistent with the spirit of justice and democracy. Given the leadership role of the United States and the significanceof the US dollar as a world currency, the interest rate mechanism of the Fed has huge externalities, whereas Fed is primarily focused on America’s own interests and (largely) ignores the impact of the decision on“the rest of the world”. The current artificially low USD interest rate isprobably the largest distortion in the world economy. The consequences are severe. Firstly, low interest rate has led to speculative hot money flows andcross-border arbitrage opportunities, which brings negative impacts on financial market stability of other countries and difficulties in policy making and financial supervision. Secondly, low interest rate leads to severe asset bubbles in emerging markets. Thirdly, low interest rate results in inefficient resource allocation worldwide. Therefore, although the current US dollar interest rate mechanism of the Fed is a suitable arrangement for the States, however it is a rather “unfair and undemocratic” system from the global perspective given the global role that USD plays. Second, the artificially low interest rate policy is a way to “reallocate (or transfer) wealth” among countries and groups, which affects the stability of financial market and monetary system. Since US treasury bonds are the main composition of China’s foreign exchange reserves, a 1% decrease in US dollar interest rate represents aboutUSD 30 billionlossin interest revenue for China, while the US Federal government, with an aggregated 17 trillion US dollar treasury bonds, saves USD 170 billion interest expenses every year. This policy is not only against the principle of justice, it alsoinvites questions on ethical issues. This is not limited to the USD interest rate policy, as we find similar situation in China, where the artificially low deposit interest rate causes wealth transfer (the recent money flow into money market funds via “internet finance channels” is simply a response to this low rate policy). Like China’s regulated deposit interest rate policy, the low interest rate policy of the States is a form of “financial repression”, but there are two differences between the two distortions: firstly the USD policy appears to be “more market-based” and thus invites less questioning; secondly the USD’s international rolemeans any USD-related repressive policy has more and complicated influence over the world economy, and is an important factor affecting the stability of international financial market and global monetary system. Third, “RMB internationalization” needs accurate interpretation and rigorous reassessment. “RMB internationalization” has been attracting more and more attention from all parts of the world.But the factis “internationalization” is only aimed at promoting the normal use of RMB on an international scale, whereas the term “RMB internationalization” may sound too grand and may lead to misunderstandings by other countries, countering the goal of RMB’s cross-border uses. In the meantime, it is worthwhile conducting a more rigorous cost-benefit analysis of RMB internationalization. We must caution the risk of RMB internationalization based primarily on the expectation of RMB’s appreciation, which would be unsustainable and will bring severe consequences, such as the disruptive impact of hot money inflow on China’s real economy and domestic financial market. Also, attention should be drawn to the pressure of RMB internationalization borne to domestic financial reform and financial system. Especially at the time of the economic downturn and higherfinancial risks in Chinese economy, the pace of RMB internationalization should be re-assessed and better managed. In conclusion, the current international monetary system is confronting the typical “prisoner’s dilemma”situation, i.e., the United States is concerned with the perceived international effort to replace the US dollar and thus loss of the privilege as the international currency, whereas other countries, including China, worry about the United States benefiting herself at other’s expense when making the dollar policies. This classic scenario in game theory is a reflection ofthe competitive dynamicsand a lack of trust between the United States and other countries in the area of international monetary system. As we all know according to economics, establishing the strategic mutual trust is the solution to the prisoner’s dilemma. An international Federal Reserve System is the solution Taking into account the international influence of the US dollar, we should consider the internationalization of the Federal Reserve System. Established in 1913, after more than a century’s test, the Federal Reserve System has proven to be an effective mechanism, with a good level of independence as well as checks & balances, (the 12 Federal Reserve Banks according to economic districts and nomination and independent voting mechanisms for 7 Board members). With the globalization, the world today is similar to the United States 100 years ago, in many ways such as the imbalance of regional development and the co-existence of multiple regional economic blocks. Therefore, we may consider building upon the current Fed system to address the deficient USD interest rate policy in the global context. For example, we can introduce non-US Fed board members with voting rights to represent the interests of other countries, regions and international organizations. Under the current international governance framework, the membership of UN Security Council and G20 will be good reference for the non-US board seats in an internationalized Fed system. This adjustment builds on the present Fed system and does not require reinventing the wheel, which could mean relatively quick adoption and acceptance by all major powers in the world. For the United States, although the adjustment may lead to the loss of some sovereignty over the USD monetary policy, the internationalized Fed will still be under its dominant leadership. For other countries, their USD related interests will be partly represented by the international members of the new Fed Board. This adjustment should help enhance the mutual trust among countries. Some people may argue that this proposal does not go far enough and is not an optimal solution, but as we know, in real life “optimality” or the best solution is not always an option, and only second best solutions are available. Take language as an example. For many people in the world, it may not be optimal for English to be the internationally spokenlanguage. Many idealists have made a lot of effort trying to influence and change this. Among the most idealistic and daring would bethe creation of the Esperanto by Polish Jew Dr. Zamenhof in 1888. Despite its “great prudence, grace, logic and expressiveness”, and the support and recognition by UNESCO in 1954, Esperanto today has only found its real usage in San Marino as an official language withlittle usage worldwide. Language and currency have many similarities, as both exhibit the “network effect” and “positive externalities” with lowest“transaction/communication costs” as the primary drivers.USD is similar to the English language, while the SDR system created in 1968 is somewhat like the Esperanto, whose current situation (of little real usage) should not be a surprise. We call for resolute leadership Although international monetary system seems to be a currency issue, or a financial or economic issue, it is actually a political issue indeed and concerns the global governance arrangement! Therefore any reform would require more resolute leadership at both country and international levels. My humble suggestions would call for the following: First, the United States should sacrifice (or share) some of the monetary policy making authority by taking the responsibility as a global leader so as to earn more respect (and collaboration) from the rest of the world. Second, other countries in the world, including China, should acknowledge and respect the cornerstone status of the US dollar in international monetary system and the continued leading role of the United States in the future US dollar policy making. While it is not the perfect arrangement, it is the second best and most feasible under the current global circumstance. Third, the current international monetary system has inherently multiple unstable elements. The “rational behavior” of every country in pursuing their own interests may lead the world to the trap in the current situation of the prisoner’s dilemma that we are presently confronting with. In order to prevent it developing into the all-lose situation, we must collaborate and act together, quickly!

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Ben Shenglin：Establishing Strategic Mutual Trust, Resolving the Dilemma of International Monetary System

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