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In Nanjing China, a seminar was held to discuss the International Monetary System (IMS) and its future. It was organized under the French Presidency of the G20. I was kindly invited to participate, along with a number of academics, most G20 participants and their advisors. Under President Sarkozy’s leadership, France seems rather keen to promote ideas about changing the IMS. The formal G20, which will be held in Cannes in November, may include some of the outcomes of these ideas that were expressed at the Nanjing meeting. Although not every G20 official participated, many did. Free from the time pressure involved in having to issue a communiqué, the purpose of the meeting was to have a more open dialogue. The media was invited to listen to the opening remarks and to meet the attendees at the end of the event. The background for the meeting was shaped by many forces, including the efforts of the G20 so far, the global credit crisis and its aftermath, and the rapidly changing dynamics of the world economy. Although brought together during the crisis, the G20 was effectively put on the stage to incorporate the BRIC countries into the centre of global policymaking. While the world’s monetary system coped well with the crisis and its aftermath, the post-Breton Woods system appears to have coincided with an increase in global financial and economic crises. This might be purely coincidental, but even if the current IMS is strong, there is a growing view that with the rise of the BRICs and the changing dynamics of the world economy, the system needs to adapt and change. I share some of these views. The location of the event itself, Nanjing, symbolizes the dynamic. Nanjing is a city of 8 million people in a province of 85 million people. At that size, it is bigger than the entire country of Germany. And, it also happens to be a city that virtually no foreign participants had ever visited or heard of before. The meeting focused on three main areas for discussion: 1. Global capital flows, their volatility and impact on local economies and policies, 2. Liquidity and the challenge of ensuring adequate global provision (including the scope for the use of the Special Drawing Rights (SDR), 3. The surveillance of the world economy. I shall discuss each briefly. GLOBAL CAPITAL FLOWS. There is widespread acknowledgement that many countries face unintended consequences of other countries’ domestic policy actions, as well as a result of their own changing engagement with the world economy and markets. As witnessed repeatedly through recent decades, there are often significant consequences when capital inflows suddenly accelerate, and even more when they abruptly halt. The focus on these issues has intensified in the past year against the background of the stimulative monetary policies across the G3. Some so-called emerging economies have witnessed dramatic inflows. Brazil is often cited as a particularly good example with $24.4 bn in net FX flows in 2010 and $33.5 bn in the first 3 months of 2011 alone. Senior IMF officials and a number of G20 members seem keen to explore some common rules to deal with these challenges in a balanced manner. In my judgment, this is likely to be difficult. At any point in time, it is never clear why capital flows one way or another. Most of us simply just guess the reasons. In Brazil’s case, for example, is it because of their very high relative interest rates? Or is because Brazil is now the 7th largest economy in the world and close to becoming its 5th? If Brazil is going to continue to grow its relative share of the world economy, in my view, the best solution for its financial markets is to further develop the depth and liquidity. In this manner, large inflows or outflows won’t necessarily have the same impact on asset prices or the currency. The same will be true ultimately for China and other large emerging economies. This is partly why we now call some of them, “Growth Economies”. Most fully developed economies have large and variable capital flows as a matter of course, and as the Growth Economies achieve their potential, the same will presumably occur. Tim Moe, Goldman Sachs Asian Equity Strategist, demonstrated the dramatic potential for a world of very different capital flows in Global Paper, no. 204 in September 2010. Not all policymakers share these views. Some think that capital flows too lazily and that there needs to be a better “order”. Reaching a consensus on a common approach to dealing with changing capital flow pressures is likely to be a tough goal for the G20. In the meantime, I suspect some countries, including G20 members, may adopt further restrictive measures to discourage large inflows. G7 WITHIN G20. As a side issue, following the recent G20 intervention to restrain the Yen, some non-G7 G20 members feel that they are not equal partners. At the same time, some G7 nations probably feel that it is easier and more effective for the G7 to act. Both sides would cite the Yen intervention to support their argument. It is not easy to argue with either side. In addition, there are signs of an additional split developing as the G7 plus BRIC countries are developing joint focus groups on the shared consequences of their actions for the world economy. In my view, this development is inevitable and will grow over time as the BRIC countries get bigger. As I often point out, two of them, China and Brazil, are within the 7 largest economies in US$ terms. At some point, if the Euro Area countries ever had the courage to represent themselves jointly, then you could see the basis for a new modern G5 and G8 emerge. The G5 would be China, the Euro Area, Japan, the UK and the US. The G8 would be this G5 plus Brazil, India and Russia. As I will discuss below, this could be also relevant for the possible growth of the SDR. Needless to say, other G20 countries are not too pleased about these possibilities. GLOBAL LIQUIDITY PROVISION. As a result of the tremendous challenges following the credit crisis in 2008, some believe that it might be difficult for central banks to repeat the remarkable coordination and agility of their actions, especially those of the Federal Reserve and ECB. While some Asian policymakers often refer to the global credit crisis as the “North Atlantic” crisis, you don’t hear that term when global liquidity issues are being discussed. Non-G7 policymakers, as well as the IMF, are those most concerned about this topic. I personally believe that there is some fundamental confusion here on two grounds. The first is the fact that liquidity itself is varies over time. While it is often abundant, it is also occasionally non-existent. That is the nature of the beast. The presence or absence of liquidity relates to confidence levels, and therefore, it is very fragile. The second source of confusion is the fact that it is the job of central banks to provide and manage liquidity. It is one of their most basic functions. Effective central banks need to be alert to the dramatic swings in liquidity preferences. Arguably, the ECB did a really good job in this regard, being the first to recognize the scale of the problem in August 2007. For some countries, their concern about a liquidity provision is a close cousin to their concerns about capital flows. In my view, the answer to both lie in more developed domestic markets, reducing the need for external liquidity and currency. Regardless of my views, there is a clear mood shift afoot for something “better” and the idea for central banks to meet in some type of committee structure under the leadership of the IMF is just one. Whether the Bank For International Settlements (BIS) is a more natural bedfellow for such a role, I shall leave to policymakers to decide. THE SDR. In the context of global liquidity, many academics and policymakers are keen to explore the potential for a greater role for the SDR in global liquidity provision. Professor Stiglitz authored an FT op-ed on the topic on Friday, summarizing the case for those who hold this view. In May 2010, Michael Buchanan and I published a paper (GS Global Paper no. 196) on the use of the SDR, in which we discussed many of the pertinent issues. A number of French and Chinese policy advisors seem to be quite supportive of a wider role for the SDR. At the extreme, the argument is essentially for a new world currency, the SDR. In my view, this would require a truly world central bank. Some see the IMF as a natural heir to a quasi-central bank in such a regard. How exactly this could be done without a world government is amongst the issues that are still quite unclear to me. And moreover, as we have witnessed in the past 12 months with European Monetary Union, operating a shared currency beyond national borders is challenging. This issue will not disappear. One key aspect of the debate that has strong and rising support is the composition of the SDR basket. To my pleasant surprise, most of the G20 members believe that the RMB should be a component – and the sooner the better. There are also some that believe other emerging currencies might become part of the SDR basket too. Currently, the SDR basket consists of 41.9 percent dollar, 37.4 percent Euro, 9.4 percent Yen and 11.3 percent Pounds. If the SDR were to reflect size and the share of world exports, as it is supposed to, the RMB would probably be close to a 10 percent weight today. Mike and I also discussed this in our 2010 paper. However, in order to be part of the SDR, a currency is expected to be available for reserve management, which normally implies convertibility and market-determined prices. This is not currently the case with the RMB. I will be surprised if the November G20 meeting doesn’t suggest some sort of timetable for an SDR basket change, possibly ahead of the next formal due date for revision, which is currently November 2015. I suspect that the IMF might need to change the 5-year review period to permit earlier alterations. This issue is not without its own considerable challenges. Some articulate a view that I share, that the implicit convertibility requirement be dropped to include the RMB as soon as possible. As some point out, when the SDR was created, this was not a condition for inclusion. In fact, it is only in the “modern” SDR where it has become so. Some who share this view also believe that it might prompt the reformers in China to accelerate the use of the RMB even more. Others see such a symbolic act as dangerous. Further, they believe that China must move to allow more freedom of use of the RMB and flexibility in its pricing first. In his public comments from Nanjing, Tim Geithner went as far to suggest that central banks would need to be independent in order for their currencies to be SDR components. To add to the complexity, it is probably the case that Chinese authorities, while happy in principle for early SDR inclusion for the RMB, would be wary of anything that implied additional external obligations. They would want policy priorities to remain domestically driven. As a final point, while the RMB is the biggest issue, others are more eager. Russia would be quite keen to see the Ruble become part of the SDR and, as their policymakers point out, the RUB in principle is now fully convertible. SURVEILLANCE. The other main topic for G20 is surveillance around many economic and financial indicators. This also involves a number of changes in IMF governance, structure, and giving it more “teeth”. Since the London G20 in 2009, and despite the absence of agreement in Seoul in November 2010, momentum towards a framework continues. The leadership of the G20, possibly through a more empowered IMF, will monitor and opine more openly on a –yet to be agreed – set of key indicators, especially for the largest G20 economies. There is considerable debate about the breadth of indicators to be included. Moreover, there remains considerable debate about the effectiveness of such a plan, even once the indicators are agreed and any pronouncements from the IMF are made. After all, as again with reference to EMU, just having announced targets for key variables doesn’t necessarily lead to them being pursued successfully. It is very likely that a lot more will emerge on the topic of surveillance. IMPLICATIONS. The potential market implications from all the above are plentiful, but will depend on what emerges. Two things for now seem clear to me. The first is that international policy cooperation is alive and well. Despite many challenges, the G20 is here to stay. It is better now that it includes the BRIC nations. The second is that the slow march of the internationalization of the RMB is set to continue, possibly even accelerate. Now back to more urgent matters, the Premiership is back this weekend, and how kind it has been to a certain just cause. Jim O’Neill |
Nieuws / Actueel / GSAM Viewpoints