Vying for a spot in the new monetary order
Alessandro Magnoli Bocchi says the exchange-rate volatility of recent years underlines the need for a more diverse global monetary system
The international monetary system needs some serious rethinking. On paper, it has to guarantee the orderly functioning of exchange-rate regimes and transnational financial flows. Over the past few years, however, most currencies' exchange rates have fluctuated at an unprecedented pace, hampering commerce and capital transfers.
At the macro level, to ensure trade relations and global prosperity, money needs to flow smoothly across countries. Since the onset of the 2008 crisis, however, periodic uncertainty about the global economy has resulted in currency volatility. Search for safety privileged the US dollar as policy intervention kept the Japanese yen and the Swiss franc from overvaluation. In the euro zone, capital flight created a quasi-currency market within the single currency area.
Monetary expansion in advanced economies and real exchange-rate appreciation in commodity-exporting economies triggered concerns about currency wars. Protectionist pressures grew, and international trade volumes declined.
At the micro level, firms need to be able to count on stable cost structures, gradual exchange-rate adjustments, predictable business outcomes and orderly rebalancing of external accounts. Instead, currency uncertainties have created managerial challenges over the past few years. Firms - in particular small and medium-sized enterprises - suffered exchange-rate volatility and its effects on costs and prices.
What is happening? Why isn't the international monetary system delivering stability as before? Because it is going through a tectonic shift, unlikely to be frictionless.
Currently, the dollar and euro - the two "global reserve currencies" - account for about two-thirds of global foreign-exchange trading and nearly 90 per cent of the foreign-exchange reserves held by central banks and governments. Still, as economic interdependence among emerging markets intensifies, firms are increasingly driven to switch trade contracts to local currencies. Furthermore, investors are voicing concerns about the future stability of the dollar and euro and a weakening of their role as a "store of value". The US and euro-zone economies are fragile and will undergo significant internal structural adjustments; these factors are likely to constrain their role as leading international currency areas. In other words, the global financial system is asking for more than one reserve currency, and a few monetary zones of regional significance.
Over the next decade, no one currency is likely to take over. The world might drift towards a multiple reserve-currency system shared among the dollar, the euro and - sometime in the future - the renminbi. The dollar will not lose its reserve-currency status and will remain the major investment currency. The euro will remain the primary alternative to the dollar. The renminbi will incrementally be accepted in trade settlements and outbound investments.
For the system to be redesigned, a co-ordinated adjustment at the global level is needed, led by the G8, to allow a change in the geopolitical monetary hierarchy. Until this process is complete, expect uncertainty and volatility to remain.
