BIS Channels Rajan as Borio Calls for New Global Monetary Orderby
Dollar-denominated system has inherent instability: Borio
Most ambitious fix would involve global monetary coordination
The world’s dollar-dominated monetary order has serious instabilities that can best be fixed by central banks explicitly coordinating policy, Claudio Borio, the chief economist of the Bank for International Settlements, argued in a new paper.
“The Achilles heel of the international monetary and financial system is that it amplifies the key weakness of domestic monetary and financial regimes, i.e. their inability to prevent the build-up and unwinding of hugely damaging financial imbalances,” Borio wrote. The “most ambitious possibility would be to develop and implement new global rules of the game that would help instill greater discipline in national policies.”
As the global economy shudders at the prospect of a simultaneous slowdown in China and tightening of monetary policy in the U.S., more attention is now being paid to the cost that countries pay when monetary or fiscal policy in other jurisdictions changes direction. Most prominently, Reserve Bank of India Governor Raghuram Rajan has argued that policy needs to be explicitly coordinated to avoid such harmful spillovers.
“How far away is the international community from finding adequate solutions? The answer is a long way,” Borio said. “There is no doubt that the dominance of one currency creates challenges” for the global system, he said.
The paper cites research showing that the dollar is involved in about 90 percent of all foreign-exchange transactions, accounts for 60 percent of official foreign-exchange reserves as well as debts and assets outside the U.S. The euro came in a distant second at about 25 percent, Borio wrote.
As the interests of domestic policy usually give little space to consideration of the spillovers to others, Borio argued that this gives rise to financial imbalances elsewhere that can “take the form of unsustainable credit and asset-price booms that overstretch balance sheets on the back of aggressive risk-taking.”
Three levels of cooperation or coordination would be feasible to lower the chances of a repeat of the 2008 global financial crisis, Borio wrote. What may not be helpful is “more pluralism” in the makeup of international currency markets, he said.
“At a minimum, enlightened self-interest, based on a thorough exchange of information, should be feasible,” the paper argues. “When setting domestic policies, countries would individually seek to take spillovers and spillbacks more systematically into account.”
Currently, Group of 20 nations agree that their monetary policies ought to avoid a spiral of competitive currency devaluations, amid persistent concerns that monetary easing is being aimed at artificially boosting countries’ export positions. In February, G-20 finance chiefs said they’d “consult” closely on policy spillovers, language seen as referring to shock moves in China and Japan that weakened their currencies.
That said, central bankers with domestic mandates usually refuse to discuss more explicit forms of policy coordination outside periods of severe turbulence.
“Cooperation could extent to occasional joint decisions, on both interest rates and foreign exchange intervention, beyond the well-honed responses seen during crises,” Borio wrote.
Yet fears over the impact of, for instance, U.S. monetary tightening are giving weight to those like Rajan who see the need to go further. The RBI governor advocates a “traffic light” system for domestic policy, with red being for measures that should be avoided due to the adverse effect they have on others.
Though the best solution would be an explicit rethinking of the global system, there’s little appetite for that now, Borio said.
“The preconditions for progress are consensus on diagnosis, which would put financial imbalances at the heart of the problem, as well as a strong sense of urgency and shared responsibility internationally,” he said. “At present, neither precondition is met.”