Why Overhauling International Monetary Systems Could Nix the Greenback

“The Financial World According to Inya” Column, by Inya Ivkovic, MA.

The Managing Director of the International Monetary Fund (IMF), Dominique Strauss-Kahn, said this week that the world could no longer rely on a single country’s currency to provide global currency stability. Hinting at the U.S. dollar’s far too many flaws, particularly in the current economic environment, Strauss-Kahn reiterated his and the IMF’s opinion that, short of having the gold standard reinstated, the departure from a single currency standard is inevitable and the eventual replacement for the dollar will have to be a basket of strong currencies. As he put it, “In a globalized world, there is no domestic solution.”

What about potential candidates that may fit the basket? The first on IMF’s mind was China’s yuan, also known as the renminbi (RMB), but not within the context of country’s economic strength. Actually, Strauss-Kahn was more interested in getting China to agree finally to let the RMB float freely, or at least allow it to gain more strength above the current price at around 6.83 RMB on a dollar. This is also the level at which the RMB was held religiously since July 2008 to ensure China’s exporters would be able to survive the severe global economic slowdown.

Strauss-Kahn commented, “We do believe firmly in the IMF that the RMB is undervalued and that it is not only in the interest of the global economy, but also in the interest of China to have a revaluation of the currency. It is now time for China, having accumulated a lot of advantages from an undervalued currency, to look more forward to investment and long-term stability, and this long-term stability goes with getting rid of this distortion.”

Advertisement

The distortion Strauss-Kahn is talking about is one that occurs when a currency is kept undervalued purposely and not allowed to flex according to the laws of a country’s fiscal and monetary policies, as well as to the laws of the international currency markets. In China’s case, the value of the RMB should have been much higher a long time ago against the U.S. dollar, to which it is pegged. Instead, the government has made sure that the RMB remained cheap to give China a distinct competitive advantage in the international trade markets. While such a strategy worked for China, it did not work for other world currencies and their respective economies, because it jumbled the price signals, often resulting in wrong decisions about currency and other investments in the long term.

Of course, the IMF is not inventing the wheel here. Washington has be arguing for years that an undervalued RMB is distorting relationships between supply and demand and was certainly one of the main factors exacerbating the global financial crisis.

Not surprisingly, China refused to be patronized or blamed for any of the “topsy-turviness” that has plagued us these past 18 months. The country’s vice foreign minister He Yafei defended its tight reins on its currency by saying that the end justified the means. The world was deep in a crisis, and keeping the RMB stable and valued low was not only a way to protect China’s economy, but also to stabilize global markets.

However, now that the strong economic headwinds have subsided somewhat, China appears open again to discuss moving towards a more floating exchange rate. Only, China wants it to happen over time, while the IMF and the rest of the world argue that there is no time to lose.

The fear is that, if nothing materially changes in the currency markets, and given time for the scars of the economic crisis to heal, the political will to overhaul the international monetary system may waver, leaving us stuck with an unstable and weak dollar standard. The momentum to cooperate must be utilized now. It is in everyone’s best interest, even China’s, to adjust to the changed world, scrap a single country currency standard and start working on that basket of currencies on which we will model future global pricing systems.