9 September 2009
Ousmène Mandeng, Ashmore Investment Management
The debate about the future of the international monetary system is taking shape. It has been driven in large part by increasing concerns about the U.S. dollar as a credible anchor for the international economy. It also emerged amid mounting dissatisfaction that the current international monetary system is prone to instability and potential collapse. Consensus now seems to have formed on moving towards adopting a multi-reserve currency system. This would potentially have widespread implications for the international economy and be the clearest sign that the status quo centered around the U.S. dollar is bound for change. The adoption of a multiple reserve currency system will not happen overnight but its implications should be felt in the short-term.
In early September, IMF Managing Director Dominique Strauss-Kahn indicated that a multi-reserve currency system is the least unlikely alterative and that new currencies are to rise in stature and international usage leading perhaps to a system with several co-equal anchor currencies. France’s central bank governor Christian Noyer also said in early September that the possible emergence of a multi-currency international monetary system deserves particular attention. Chinese and Russian officials have previously offered their visions on what essentially would amount to a diversified international currency system.
The intellectual debate on the outlines of a new international monetary system therefore appears to have been largely won. Alternatives, such as perpetuation of the status quo, predominance of the Euro in lieu of the dollar and convergence toward a new hegemonic currency, the IMF’s SDRs or an international currency no longer seem desirable, are not feasible or may not constitute complete solutions. The fact is that the international system already operates with several currencies. The aim now will be to allow greater balance among those currencies.
While there is no single alternative to the dollar today, the idea is to establish complementary regimes that will allow for a gradual and orderly rebalancing of the international monetary system. The objective should be to institute greater symmetry, namely to align the mounting disparity between countries’ economic and monetary weights and ease changes in currency parities. The former would help match broad-based economic diversification with greater monetary diversification helping establish greater symmetry between activity and currency usage. The latter is set to help in particular the U.S. to conduct balance of payments adjust- ments. Both seem essential elements to put the international economy on a sounder footing.
Emerging markets currencies seem the obvious suppliers of new currencies given their increasing economic weight. Yet, the main candidates maintain significant hurdles for allowing their currencies to be adopted for international monetary transactions, notably the Chinese renminbi and the Indian rupee. Others may not yet offer sufficient reserve-type securities to meet basic reserve management criteria, like e.g. the Russian rouble or Saudi Arabian riyal. Others already provide good access like Brazil, Korea, Mexico and South Africa. As such, conditions for establishing a multi-currency system depend to a large extent on the issuing countries themselves. Several rather than fewer currencies should join the reserve currency fray to overcome general limitations of using national currencies often associated with the so-called Triffin dilemma.
The market is already active in emerging markets local currency products. The asset class has become by far the most important among emerging markets portfolio assets and is set to grow fastest as emerging markets funding will increasingly shift to domestic sources. If central banks were to allocate part of their international reserves to emerging markets domestic assets it would undoubtedly provide a boost to the asset class and help foster develop- ments of those markets further. This in turn would attract more issuers, establish greater market depth and broaden the variety of investable instruments. The availability of local currency funding would strengthen financial conditions of domestic entities reducing reliance on external funding thus curbing foreign exchange risk and dependence on off-shore financial institutions that may constitute a bottleneck for intermediating financial resources in times of generalised distress.
Concerns about central bank international reserve diversifi- cation refer above all to the credit attributes of new currencies but also to feasible transaction sizes. The former is likely to limit candidate currencies to higher grade currencies. Policies supportive of lending stability to the curren- cies will be a necessary condition; part of the credit quality however itself will also be endogenous to central bank allocations, that is, the dollar is at least in part so attractive because China decides to hold it. The limited depth of new local currency markets represents a major obstacle for large transactions but should not be a hindrance to smaller allocations. Emerging markets local government debt securities represent about 15 percent of total government securities outstanding which allows for sufficient initial holdings.
The main concern is about providing sufficient conditions for an orderly exit from the dollar and entry into new currencies. Implementation of a multiple reserve currency will be gradual and ideally should probably be transparent. A road-map towards implementation would help to anchor market expectations and allow issuing countries to take supportive steps. The central bank gold sales agreement could provide a suitable framework by which central banks would agree to the pace by which they would aim at substituting conventional currencies for new currencies. Such allocations may be restricted to the reserve flow but may also involve stock operations.
Central banks have an opportunity to guide and lead the adoption of a new international monetary system. Their substantial international reserves provide sufficient resources to channel interest and define the process. Changes in reserve allocations do not require complex agreements as central banks can opt for unilateral implementation, although a coordinated approach may be beneficial. Currency selection will be determined by demand and supply and some explicit and implicit currency competition will likely take place.
The upcoming G20 summit has the opportunity to adopt the reform of the international system as an official agenda item. This would be the clearest sign yet that policy makers are serious about reform. The market shows that conditions for a gradual adoption of new reserve currencies are sufficient today. The BISMARCK currencies (Brazil, India, South Africa, Mexico, Saudi Arabia, Russia, China, Korea), no association whatsoever intended with Germany’s 19th century statesman and avid reformer, seem the obvious candidates to promote a new multi-currency system. Such a move may not be as ambitious as the 1944 Bretton Woods agreement but it would come very close indeed.