“Considerations on Reform of the International Monetary System:” Zhou Xiaochuan, March 2009

Translation of the essay “Considerations on Reform of the International Monetary System” (关于改革国际货币体系的思考) by Zhou Xiaochuan, governor of the People’s Bank of China, published on 23 March 2009.

The explosion and spread of the current financial crisis has compelled us to once again face an ancient and still unresolved problem, this being what kind of international reserve currency is capable of maintaining global financial stability, and expediting the world’s economic development.

History’s silver standard, gold standard, the Gold Exchange Standard and the Bretton Woods system are all different systemic arrangements for resolving this problem, which is also one of the purposes for the establishment of the International Monetary Fund (IMF). However, the current financial crisis clearly indicates that not only is this problem far from being resolved, but is in fact becoming more and more intense as a result of internal defects in the international monetary system.

In theoretical terms, the value of an international reserve currency should have a stable benchmark and clear issuance rules for the purpose of ensuring orderly supply. Secondly, it should be possible to increase or reduce total supply promptly and flexibly on the basis of demand. Thirdly, such adjustments must transcend the economic conditions and interest of any one country.

Our current usage of sovereign credit money as the main international reserve currency is a rare instance in history. The financial crisis once again warns us that it is necessary to creatively reform and improve the existing international monetary system, and drive international reserve currencies in the direction of stable currency values, orderly supply and adjustable total volume, in order to be able to fundamentally preserve global economic and financial stability.

I. The explosion of the current financial crisis and its rapid global spread reflects the existing international monetary system’s intrinsic defects and systemic risk

With respect to the issuance of reserve currencies, the goal of domestic monetary policy will often conflict with the needs of different countries when it comes to reserve currencies. Monetary authorities cannot overlook the international role of their own national currency in order to give exclusive consideration domestic goals, nor it is possible for them to give equal consideration to different domestic and overseas goals. This could leave them unable to fully satisfy the needs of a constantly growing global economy because of the need to suppress domestic inflation, while excessive stimulus of domestic demand can also lead to an overflow of global liquidity. Theoretically the Triffin dilemma still exists, which is that nations that issue reserve currencies are unable to preserve the stability of their currencies while providing the world with liquidity.

Once a country’s currency becomes a currency for pricing the whole world’s primary products, a currency for trade settlement and a reserve currency, that country’s exchange adjustments to address economic imbalances are ineffective, because the currencies of many other countries all use its currency for reference. Economic globalisation both benefits from a commonly accepted reserve currency, as well as harmed by the defects of the system for issuance of such a currency. Given that following the collapse of the Bretton Woods system financial crises have repeatedly occurred as well as become more intense, the price paid by the whole world for the current monetary system perhaps exceeds the benefit it derives from it. Not only have countries that make use of reserve countries paid a heavy price, the issuing countries have also paid an increasingly heavy price. Crises are not necessary deliberately inflicted by the authorities that issue reserve currencies, but are a necessary outcome of systemic defects.

II. The creation of a international reserve currency that it unconnected with sovereign nations, and capable of maintaining long-term stable value, thus avoids the intrinsic defects of using a sovereign credit currency as a reserve currency, and is the ideal goal for reform of the international monetary system.

1. While the concept of a supranational reserve currency has been around for a long time, as of the present there has been no substantive progress. In the 1980’s Keynes proposed the concept of establishing an international monetary unit, “Bancor,” that would adopt 30 representative commodities as the foundation for its value, but unfortunately this has yet to be implemented, while the subsequent the collapse of the Bretton-Woods system that has the White plan as its foundation indicates that Keynes’ plan was perhaps more far-sighted. When the defects of the Bretton-Woods systems were first revealed, the IMF established special drawing rights in 1969, in order to ease the intrinsic risk of using sovereign currencies as reserve currencies. Unfortunately, because of allocation mechanisms and restrictions on usage scopes, at present the role of SDR’s has yet to be fully utilised. However, the existence of SDR’s provides a ray of hope for reform of the international monetary system.

2.A supranational reserve currency would not only overcome the risk intrinsic to sovereign credit currencies it would also provide the possibility of adjusting global liquidity. Because an international reserve currency managed by a global institution would  make the creation and control of global liquidity a possibility. When a single country’s sovereign currency no longer serves as the measure of global trade and the reference standard, that country’s exchange rate policies will see a huge increase in their effectiveness when it comes to adjusting imbalances. This will greatly reduce the risk that future crises would occur, and strengthen the ability to handle crises.

III. Reform should set its sight on the big picture, work on the details, adopt a gradual approach and seek joint-victory

The re-establishment of an international reserve currency that possesses a stable valuation standard and is accepted by all countries is perhaps a goal that can only be achieved in the long-term. The establishment of the international currency unit as proposed by Keynes is also a bold vision for humanity, and will require that politicians from all nations muster extraordinary foresight and courage. In the short-term, however, the international community, and in particular the IMF, should at least admit to and frankly confront the risks generated by the existing system, and continually monitor and assess them, as well as provide prompt warnings.

At the same time we should give special consideration to fully utilising the role of SDR. SDR possess the features and potential of a supranational reserve currency. At the same time its expanded issuance would be of benefit overcoming the difficulties faced by the IMF with respect to reform of costs, speaking rights and representation rights. For this reason we should endeavour to advance allocations of SDR. This requires that all member nations engage in active political cooperation, and in particular ratify the 1997 fourth amendment of the Articles of Agreement and corresponding SDR allocation agreement, in order to enable those member states that joined after 1981 to be able to enjoy the benefits of SDR. On this basis we can give consideration to further expansion of SDR issuance.

The usage scope for SDR must be expanded, thus making it possible to truly satisfy the requirements of all countries with respect to a reserve currency.

-Establish settlement relationships between SDR and other currencies. Change the current situation where SDR can only be used for international settlement between governments or international entities, in order to make it become a generally accepted payment medium for international trade and financial transactions.

-Actively promote the use of SDR as a unit of account in international trade, commodities pricing, investment and corporate accounting. This will not only be of benefit to strengthening the role of SDR, it could also effectively reduce the asset price fluctuations and associated risk created by the use of sovereign reserve currencies for pricing.

-Actively promote the creation of assets that are priced in SDR, strengthening its appeal. The IMF is currently researching the pricing of marketable securities in SDR, and if this goes ahead would be a good starting point.

-Further improve the valuation and issuance methods for SDR. The basket of currencies used for SDR valuation should be expanded to include all of the world’s major economies, and GDP could be used as one of the factors when giving consideration to weighting. In addition to this, in order to further increase the market’s confidence in its value, the issuance of SDR could also shift from artificial calculation of value to use of actual assets for support. We could also give consideration to absorbing the current reserve currencies of various countries to serve as a preparation for issuance.

IV.The centralised management of a portion of the reserves of member states by the IMF will not only be of benefit to strengthening the ability of the international community to respond to crisis and maintain the international monetary and financial system, it could also serve as a vigorous means of strengthening the role of SDR.

1.The centralised management of global reserve funds by a trusted international organisation, as well as the provision of reasonable returns to attract the participation of countries, will permit the more effective utilisation of reserve funds and have a greater deterrence and stabilisation effect upon speculation and market panics, as compared to each country making diffuse usage of reserve funds and waging war on its own. For the participation nations, this will sos be of benefit to reducing the reserves needed, and cutting down on funds used for development and growth. There are many IMF members, while the IMF is also the only international organisation in the world entrusted with the responsibility of preserving monetary and financial stability, that is capable of performing supervision of the macro-economic policies of member states. It possesses corresponding specialisation advantages, and a natural advantage when it comes to management of the reserves of member states.

2. The centralised management of member state reserves by the IMF will also serve as a vigorous means ensuring that SDR play a greater role as a reserve currency. The IMF can give consideration to the creation of an open-model funds based on a marketised model, for the centralised management of the existing accumulation of reserve currencies of member nations, setting the SDR as the unit of account for funds, and allowing various investors to freely subscribe by means of existing reserve currencies, and when needed redeem reserve currencies which are required. This will both promote the development of SDR priced assets, as well as partially achieve adjustment of global liquidity in existing reserve currencies, and even serve as a foundation for expanding SDR issuance, and gradually replacing existing reserve currencies. (fin)