Reshaping the G20’s Image to Promote the Reform of International Monetary System

Reshaping the G20’s Image to Promote the Reform of International Monetary System

(By Xu Hongcai, Presentation at Northwestern University, in Chicago, on May 10, 2012)

Good morning, ladies and gentlemen:

I am very glad to participate in today’s discussion. My topic is “Reshaping the G20’s Image to Promote the Reform of International Monetary System”. I want to focus on two issues: first one is the G20’s challenges; second one is the proposals for the G20’s role in the reform of international monetary system.

I. The G20 is Facing Serious Challenges

In 1999, The Group of Twenty (G20) came into existence, and held the first G20 conference of finance ministers and central bank governors. Three years ago, the G20 leader summit was established as the highest global forum in order to mobilize coordinated leadership and tackle the global financial crisis. Since then, the G20 has become an important platform for global issues, such as international economic governance, and international economic policy coordination, particularly for the reform of the international monetary system. This is why people around the world have come to expect much of the G20.

However, the G20 seems to be increasingly turning into a talking shop, following the precedent of the United Nations. The UN has had the bad reputation of being just a talking shop for a long time, because its very large membership makes it difficult for it to reach any consensus. Its policy-making capability and implementation performance are usually disappointing, even though its legitimacy and representation are beyond doubt. Similarly, one of the continuing challenges faced by the G20 is to juggle the particular interests of the member states with its broader mission to serve the international community. This is the root cause behind the low efficiency of the G20.

In my opinion, the G20 is encountering a series of simultaneous practical challenges. First among them is the huge negative spillover effect from the monetary policy in systematically important countries. Second, the acute fluctuation of the exchange rate of reserve currencies has resulted in the worsening stability of global financial system. Third is the rise in trade and investment protectionism. Fourth, the gap between global North and South is broadening. The conflict among different interests is worsening. Last, most importantly, IMF has played a slightly blurry role in the reform of the international monetary system.

The outbreak of the global financial crisis in 2008 reflects the inherent vulnerabilities and systemic risks in the existing international monetary system. The issuing countries of reserve currencies are constantly confronted with the dilemma between achieving their domestic monetary policy goals and meeting other countries’ demand for reserve currencies. Today, the most urgent task for the G20 is to reshape its image and focus on the reform of the international monetary system.

II. The Proposals for the Role of G20 in the Reform of International Monetary System

(I) Reforming the IMF and Deepening the G20-IMF Linkage

It has come to light that using a national currency as the global reserve currency is not adapted to the situation of the world economy today. With sharply fluctuating exchange rates, it is difficult to monitor international capital flows, identify financial risks in advance, and save the global system once a crisis happens. If the current international monetary system cannot be successfully reformed, a new great financial crisis will soon be upon us. So, the G20 should focus on its historical mission to urgently reform the international monetary system.

In order to realize this mission, the G20 should set up a permanent secretariat within the IMF in order to improve its policy-making capability and implementation performance. Through in-depth communication, the G20 should put together a reform agenda for the international monetary system. This reform agenda should include a consensus on the guiding ideology, basic principles, clear reform objectives, a concrete action plan, and the respective responsibilities of each nation.

The traditional function of the IMF is to advance international trade and promote healthy balance-of-payments situations. The IMF should exercise its role fully and turn the Special Drawing Rights (SDRs) into a new international reserve currency. It should also supervise the economic behavior of its member states, provide an early warning system, as well as rescue economies in the advent of a financial crisis. Broadly speaking, the IMF should prevent systemitic risk, secure global financial stability, and in particular, supervise the issuance of major international reserve currencies and the cross-border flow of international capital.

Meanwhile, it has become necessary to reduce the weight of the U.S. dollar in international reserves, and thus gradually change the current “single” monetary system centered on the U.S. dollar to a diversified international monetary system consisted of multiple currencies, such as the SDR, the U.S. dollar, the Euro and the RMB. Reforming the international monetary system through the diversification of international reserves has two main features. On the one hand, the U.S. dollar should continue to play an important role in the long term. On the other hand, other currencies such as the Euro, the Pound, the Yen, and the RMB should play a great role in the international reserve currency.

(II) Strengthening International Cooperation and Improving the Coordination of Economic Policies

Today, it is crucial to strengthen global cooperation in order to address the ongoing sovereign debt crisis in the Euro-zone and impose supervision on the main reserve currency. The IMF should make some normative provisions on the international reserve currency in order to reduce the negative impact of monetary policy spillover.

Second, the U.S. Federal Reserve and the European Central Bank (ECB) should raise their interest rates and bring real interest rates back to zero. Meanwhile, the emerging economies should follow and increase their interest rates moderately so as to curb global inflation. The IMF should supervise the implementation of prudential exchange rate policies.

Third, the IMF should also further build up its ability to coordinate the economic policies of its member states. It should also bolster its role as global lender of last resort and its ability to provide medium and long term loans to help member states overcome balance-of-payments difficulties.

In addition, the IMF should be granted new responsibilities to supervise the currency stability of the systematically important countries.

(III) Reforming the Special Drawing Rights System

It is imperative to include the currencies of emerging economies in the SDRs’ currency basket and reform the adjustment and distribution of the SDRs. The IMF should make the SDR currency basket reflect more accurately the state of the world’s economy, and make the SDRs play an important role in international clearing, commodity and asset pricing, as well as in international reserve assets.

A good way to start the reforms would be to encourage the use of SDRs for a broader range of activities and to start reducing the weight of the U.S. dollar in the reserve currency system. In the long run, the SDRs should eventually be used in international transactions, in domestic currency transactions, and become a reserve currency. The international community should also push the internationalization of the RMB to reduce the “burden” of the U.S. dollar in acting as the reserve currency.

Therefore, relevant IMF rules should be revised by authorizing the IMF to issue the SDRs at its own discretion in accordance with the demand in international financial markets. The IMF should also be allowed to purchase corresponding financial assets (such as government bonds of member states) with the SDRs. Meanwhile, the member states should be allowed to engage in international trade and investment activities with the SDRs borrowed from the IMF. In essence, such reform would mean granting the IMF the ability to conduct open market operations as the world's central bank.

 (IV) Establishing Four Mechanisms in the International Monetary System

The first is to build an international supervision mechanism for reserve currencies and to let the IMF take the responsibility for supervising international reserve currencies. When an international reserve currency is devalued, the IMF would issue a timely warning and put pressure upon the country to stabilize its currency.

The second is to establish a mechanism for international reserve currencies to compete on an open market. It could take a long time to build the SDRs into a “super-sovereign” international reserve currency, but a diversified system in which several major currencies jointly function as reserve currencies would encourage countries that issue reserve currencies to maintain the stability of their respective currencies.

The third is to improve the international financial crisis bailout mechanism. In the previous financial crises, the IMF usually reacted slowly and in some cases even aggravated the situation. The IMF should increase its effectiveness in providing funding support for liquidity-deficient countries, perhaps even through the use of SDRs assets.

The fourth is to improve collaboration and division of labor between the Bank for International Settlements (BIS) and the IMF. The collaboration and balance between the two organizations can increase governance efficiency, decentralize risks, and maintain global financial stability.

In reality, the IMF could be compared to a joint-stock company. The reform of quota shares and voting rights is to do away with the unreasonable fact that the U.S. and the EU together (especially when Japan and Canada are added) control the large majority of veto rights. In addition, it is also necessary to reform the election procedures for the senior leaders of the IMF, the seats on the executive board, and the diversity of its employees. The distribution of the voting rights in the IMF should be commensurate with the economic strength of its different member states.

(V) Reforming the World Bank’s Governance

The World Bank should step up its loan support and technical assistance for developing countries, and contribute to global economic stability by strengthening its investments in the production and service areas, and by encouraging international investments. It is crucial to enhance the role of the World Bank in stabilizing the international financial system and to enlarge the functions of the World Bank Development Committee. The World Bank should also play its role in assisting vulnerable countries to reduce their financial risks, and should strengthen the funding assistance for countries impacted by financial crises at the regional and global levels.

(VI) Reforming the BIS’ Governance

The BIS has focused on supervising monetary and financial transactions between the BIS and the central banks of its member states and helping them handle the conversion of official reserve currencies. The BIS should help the IMF to increase the weight of SDRs in trade, currency and financial clearing transactions of different countries, and to enlarge the position of the SDRs in the international clearing system. Depositing the SDRs at the BIS, instead of the IMF, would decentralize risks. Establishing an international financial risk warning system centered on the BIS could be another good idea.

(VII) Supporting the Emerging Economies’ Participation

Given their growing share in the world economy, emerging economies should play a greater role in global economic governance. This would enable them to take a greater responsibility for the global system and would reduce the burden of developed economies. For example, the internationalization of RMB will reduce the burden on the U.S. Dollar. Today, it is urgent to establish a competitive structure of “three pillars” that includes the U.S. dollar, Euro, and RMB. In this situation, it would be a good idea to promote the SDR as a global anchor, in order to realize a more stable exchange rate system in the world.

(VIII) Encouraging the Think Tanks’ Participation from Member States

The G20 should build a network of think tanks from different member states under the coordination of the IMF. The previous experience suggests that think tanks may play an unique role in global economic governance. The G20 members could choose their leading think tanks to facilitate relevant academic exchanges between member states. In the case of China, for example, the China Center for International Economic Exchanges (CCIEE) could be an ideal candidate, and is capable to take a leading role.

Thank you for attention.