Thomas Fuster

The courage to coexist

A reply to the text by Justin Yifu Lin

A multipolar monetary regime leads to better money

A multipolar monetary regime leads to better money than a supranational single currency. This kind of coexistence even forces the USA to constantly re-earn its monetary supremacy.

The idea of a world currency has been one of the hot topics in economic history. John Maynard Keynes once dreamt of a single global accounting unit. The currency he called Bancor failed due to USA’s opposition at the Bretton Woods conference in fact, where the waters were being tested for the world economic post-war order in 1944. Back then, as probably is also the case today, Washington did not want to sacrifice the supremacy of the dollar and the associated privilege at the altar of a new supranational construct. Decades have passed since then during which the end of the dollar as a global leading currency was often prophesied The fact remains that the dollar still holds the most important position by far in the global economy.

Coming and going

Its dominance is also revealed in the central banks’ currency reserves. Although it cannot be exactly determined in which currencies these reserves are financed, as the monetary authorities only report this sensitive information to the International Monetary Fund (IMG) on a voluntary and confidential basis. The allocation to individual currencies is only published for roughly half of all the currency reserves. But if you take this data as a benchmark, the dollar is currently responsible for 64% of all currency reserves, considerably more than the euro with 20% and the British pound with 5%.

The supremacy of the dollar occasionally causes resentment. Anyone accusing the USA of hegemonic intentions, can also see this suspicion confirmed at a monetary level. The supremacy of the dollar is not carved in stone though; it rather reflects the issuer’s economic and political power. A glance back at history clearly shows this. For example, the Dutch gilder acquired a reputation as a global leading currency between the 17th and 19th century. Afterwards the British colonial power, or pound, slipped into this role before the dollar established itself after the First World War and then really asserted itself after the Second World War. The importance of the dollar as a leading currency has been diminishing though since the Bretton Woods system was buried in 1973 and the changeover to flexible foreign exchange rates was made.

History shows that the USA cannot be certain of retaining its current privilege. The leading role always has to be earned, especially in a monetary regime with flexible foreign exchange rates. The current regime, often called a non-system, has not been unipolar for a long time but is increasingly marked by multipolar traits. This can be attributed to the euro, which was first born in 1999. Firstly, Europe’s single currency has been the most important currency since 2000 for the Swiss National Bank’s currency reserves; its share is 42%, clearly way ahead of the dollar with 34%. Secondly, in light of China’s increasing weight the international use of the renminbi is also likely to increase if the state opens up the movement of capital more in future.

Trust in the competition

For Justin Yifu Lin (see text opposite), this system of multiple reserve currencies is inherently instable. But that doesn’t have to be the case. The competition may, for example, act as a disciplining factor between currency areas. I.e., if states lose faith in a currency’s value, for example because the central bank is running a too expansive policy or the currency area is battling with structural problems, the reserves are switched to other currencies. This leads to stronger diversification of the currency allocation and is more beneficial to the financial system’s stability than the concentration risk of a centralised “one-size-fits-all” solution.

But Lin think this discipline function of competition will not work due to the structural weakness of each of the reserve currency countries [1] . He is vehemently campaigning for a supranational solution, for a global reserve currency, which combines the advantages of paper money with the stability of gold. The idea of this “paper gold” may look elegant on the drawing board. But is it workable? Probably not. Central banks will not voluntarily be willing to hand over their monetary policy flexibility to a super central bank and chain their currency to a new reserve currency. In an economically extremely heterogeneous world it would also be a bit of an illusion to hope for a consensus on the degree of the required global monetary expansion. Also, who would decide the devaluations and revaluations when economic weights shift? And who would enjoy the seigniorage, i.e. the profit from issuing currency?

It’s unrealistic [2] to believe that the new super central bank would be staffed exclusively according to professional qualifications. Influential states are more likely to try to push their stakeholders into the institution. Purely neutral technocrats also would not set the tone with the annually determined expansion of the paper gold but politically motivated powers would. The Trilemma, the impossible trinity in international economics, would also stand in the way of the project: this means that out of the three goals of an independent monetary policy, a fixed foreign exchange rate and free movement of capital only two would be possible. The paper gold would therefore result in a restriction in the movement of capital. Lin is primarily aiming at blocking portfolio investments. But which democratically legitimised authority can and is allowed to set up these kinds of barriers?

Risk of politicisation

The listing of these political and economic sources of conflict makes it clear: the propagated introduction of a supranational reserve currency would result in a hopeless politicisation of the global reserve system. The battle for influence on the new and global central bank would not lead to more but to less (monetary value) stability.

The opposite, namely the depoliticisation of money, would promise more solidity. This does not have to imply a total privatisation of the monetary system as Friedrich August von Hayek once postulated. But the fact is that the disciplining force of competition also leads to better quality with money, namely on a multilateral level. This speaks against a sovereign monopoly currency that has the rather presumptuous objective of wanting to equally do justice to all world regions.

The dollar currently best fulfils the conditions for a reserve currency: the American economy and Fed enjoy international trust. The USA also has a well developed and liquid capital market. However, rival currency areas like the eurozone or China are welcome to build up a similar level of trust with an unlimited convertible currency and create an attractive capital market for investors. However, this requires a good locational quality for business and cannot be achieved by supranational decree.

[1] It is not that I do not believe in competition. It is that the precondition for competition to have a decipline effect does not exist.

 [2] The word “naïve” may be too strong. I suggest to use ”unrealistic” instead.

Thomas Fuster

Thomas Fuster war Ostasien-Korrespondent für die NZZ, ist jetzt Wirtschaftsredaktor und kümmert sich dort vor allem um makroökonomische Themen.

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