The fate of the global monetary system

Tue, 9 Nov Pre-Open

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The financial crisis has widened cracks in the global economy and the international monetary system. As if the mortgage crisis and the consequent recession in the developed economies was not enough, problems of excess debt in Europe and the US emerged. And the latest has been fears of currency wars escalating.

The blame game begins with the US and China. The US has been complaining for quite a while now that the Yuan is undervalued and has been putting pressure on China to let it appreciate against the dollar. China, in the meanwhile, opines that the current crisis in the currency markets is mostly due to the loose monetary policy being followed by the US. What is more, the US expansionary policy is hurting not just China but other Asian economies as well. This has been largely in the form of surge in capital inflows which have caused their currencies to appreciate. Meanwhile, exports are not picking up because demand in the Europe and the US continues to remain sluggish.

As a result, today's international monetary system is being increasingly questioned. For starters, the US dollar has held a dominant position as the world's reserve currency. According to the Economist, majority of the foreign-exchange transactions and reserves are in dollars. Even though the US accounts for only 24% of global GDP. As a result, many countries are vulnerable to US' domestic monetary policies. This has then led many countries to question the supremacy of the dollar. Emerging nations such as China are increasingly calling for lesser dependence on the US dollar and more importance to a basket of currencies.

Then another anomaly that the current monetary system has thrown up is the accumulation of vast reserves. Notably by emerging nations such as China. In other words, emerging and relatively poorer nations really require capital for their own investment purposes. But they are lending to richer nations such as the US. And Americans, in the meanwhile, are not spending which has compounded problems further. Not just that, the surge in capital inflows in emerging nations such as India and China have put central bankers in these countries in a quandary. For most of it is hot money. While this has been gushing in right now, it can also flee at the drop of a hat once the US recovers.

And so, the international monetary system stands precariously at the edge. The US has not helped matters by resorting to a second round of quantitative easing. This has raised fears of the soundness of the paper currencies given that they are being printed indiscriminately. The gainer here has been gold. Gold prices have surged as investors are looking for safer havens for parking their funds. The fact that it is a tangible asset, has also found favour among many. In the meanwhile, the World Bank, in view of these currency tensions, has proposed that leading economies should consider readopting a modified global gold standard to guide currency movements. It remains to be seen whether this proposal will actually be followed. Indeed, these are tough times for governments and central bankers around the world.