French Finance Minister Christine Lagarde said a world with a single reserve currency is vulnerable to economic crises, underlining the need for more global policy coordination in the face of trade imbalances.
“The fact that there is only one reserve asset but several economic areas is a source of vulnerability,” Lagarde said in a speech in Paris today. “It leaves us exposed to financial turmoil in the event of fast depreciation.”
The dollar’s role as the linchpin of the global monetary system has come under attack from some policy makers since the 2008 financial crisis. Zhou Xiaochuan, governor of the People’s Bank of China, has proposed that the International Monetary Fund take over leadership of the global monetary system from the U.S.
Russian President Dmitry Medvedev has also questioned the role of the dollar and his government aims to diversify its reserves, the world’s third biggest, and promote the use of regional currencies in international trade and finance to reduce risks posed by the dominance of the dollar.
The remarks, made at a conference organized by the Re-Inventing Bretton Woods Committee, reflect French thinking at a time when President Nicolas Sarkozy holds the chairmanship of the Group of 20 nations that are trying to set global economic policy in the wake of the financial crisis. France is aiming to foster discussion about the monetary system rather than impose a specific vision, Lagarde said.
“France does not have the ambition to provide ready-made solutions,” Lagarde said. “We don’t have a magic wand, we don’t have a philosopher’s stone. You are going to participate in that decision,” she told the audience of central bankers, economists, academics and government officials from around the world.
Reducing trade imbalances that are blamed in part for the 2008 financial crisis, together with setting out a new framework for a global monetary system are among the top priorities of the G-20. Heads of government of the group gathered for the first time in November 2008 in Washington as the world grappled with the after-effects of the collapse of Lehman Brothers Holdings Inc. and the injection of billions of taxpayer money into the banking systems of the U.S., Britain and other countries.
The existence of one reserve currency wouldn’t be a problem if that currency remained stable, Lagarde said. In recent years, though, increasingly volatile foreign exchange markets are undermining global economic growth and proving a growing challenge for companies that are trying to trade beyond their own borders.
Lagarde also repeated France’s view that one possible way to address trade imbalances would be to offer a financial safety net to developing countries. The volatility of exchange rates and capital flows has disproportionally threatened emerging market economies in recent years, Lagarde said, prompting them to accumulate massive reserves, distorting trade patterns and the global economy.
“Emerging economies are the first victims of this lack of limits on capital-flow volatility,” she said. That “creates a need for self insurance through reserve accumulation, which itself contributes to global imbalances. It leads to sub-optimal capital allocation and makes it much harder for an emerging country to issue local currency denominated debt, therefore leaving it more exposed to exchange rate fluctuations,” she said.
Coordination between governments is essential for confronting the problem in the French government’s view. “We cannot operate in a vacuum, we are all interdependent,” Lagarde said.
The Group of Seven nations is no longer the ideal forum for managing the global monetary system, she added. “Currency issues use to be dealt with at G-7 level,” Lagarde said. “Is a G-7 that doesn’t include the second-largest economy in the world” the most appropriate forum for that? “I don’t think so,” she said.