Wednesday, August 18, 2004
A Global Currency?
Okay, I know most of you have raised eyebrows/are smirking already. Indulge me, or rather, indulge Martin Wolf for a little bit and read on. On the occasion of the 60th anniversary of the Bretton Woods conference, it's a worthwhile question to ask whether floating exchange rates are a good replacement for the adjustable exchange-rate pegs of the Bretton Woods twins. Wolf doesnt think so. In the wake of attending two conferences on global finance (including one organised by, who else, Robert Mundell), Wolf wrote thusly in the Financial Times.
Consider the following features of the world economy today: the world's richest country is, far and away, its biggest capital importer and net debtor; the two periods of sizeable net lending to emerging market economies over the past three decades ended in financial crises and sharp reversals in lending (see chart); and, since the most recent set of global crises, emerging market economies have, in aggregate, accumulated enormous quantities of foreign currency reserves.
Ninety-seven per cent of all debt placed in international markets between 1999 and 2001 was denominated in just five currencies: the US dollar, the euro, the yen, the pound sterling and the Swiss franc. Even well-run emerging market economies, such as Chile, cannot borrow in their own currencies. Whatever the explanation for this difficulty, the limited currency composition of global lending has powerful consequences for capital flows. By definition, net borrowing then creates a potentially lethal currency mismatch. When a currency falls sharply, net borrowers will experience large balance sheet losses. Many financial institutions will be wiped out as a result of the insolvency of any debtor that is burdened by large net foreign currency liabilities.
Having either experienced this pain or watched other countries do so, competently run emerging market economies have tried to limit their net foreign currency liabilities. This has been particularly true of the Asian emerging market economies. These countries have attempted to preserve robust current account positions. They have also recycled inflows of foreign direct investment into official holdings of foreign currency assets, principally US treasury securities.
A world in which borrowing abroad is hugely dangerous for most relatively poor countries is undesirable. A world that compels the anchor currency country to run huge current account deficits looks unstable. We should seek to lift these constraints. The simplest way to do so would be to add a global currency to a global economy. For emerging market economies, at least, this would be a huge boon.
Consider the following features of the world economy today: the world's richest country is, far and away, its biggest capital importer and net debtor; the two periods of sizeable net lending to emerging market economies over the past three decades ended in financial crises and sharp reversals in lending (see chart); and, since the most recent set of global crises, emerging market economies have, in aggregate, accumulated enormous quantities of foreign currency reserves.
Ninety-seven per cent of all debt placed in international markets between 1999 and 2001 was denominated in just five currencies: the US dollar, the euro, the yen, the pound sterling and the Swiss franc. Even well-run emerging market economies, such as Chile, cannot borrow in their own currencies. Whatever the explanation for this difficulty, the limited currency composition of global lending has powerful consequences for capital flows. By definition, net borrowing then creates a potentially lethal currency mismatch. When a currency falls sharply, net borrowers will experience large balance sheet losses. Many financial institutions will be wiped out as a result of the insolvency of any debtor that is burdened by large net foreign currency liabilities.
Having either experienced this pain or watched other countries do so, competently run emerging market economies have tried to limit their net foreign currency liabilities. This has been particularly true of the Asian emerging market economies. These countries have attempted to preserve robust current account positions. They have also recycled inflows of foreign direct investment into official holdings of foreign currency assets, principally US treasury securities.
A world in which borrowing abroad is hugely dangerous for most relatively poor countries is undesirable. A world that compels the anchor currency country to run huge current account deficits looks unstable. We should seek to lift these constraints. The simplest way to do so would be to add a global currency to a global economy. For emerging market economies, at least, this would be a huge boon.
