What’s wrong with the international monetary system?

WHAT ARE WE TO DO By TAN SRI LIN SEE-YAN

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President Johnson stated in 1968: “To the average citizen, the balance of payments, the strength of the US dollar, and the international monetary system are meaningless phrases. They seem to have little relevance to our daily lives. Yet, their consequences touch us all consumer and captain of industry, worker, farmer and financier.”

This is true when international financial arrangements are working well; and becomes even more evident when they are not. While not all would argue there is no life left in the international monetary system (IMS), almost all would agree the present system contains inherent contradictions which lead to frequent breakdowns.

Basic principles

Four basic principles underlie the IMS: (i) a country’s sovereign right to regulate internal demand to maintain stable conditions at home in terms of employment and domestic prices; (ii) free international movement of goods and capital and here, substantial progress has been made in meeting this goal; (iii) a system of mixed exchange rate regimes – from fixed exchange rate (eg China) to flexible exchange rate (eg US dollar, British pound and euro) to degrees of managed floats (eg yen and the ringgit); and (iv) a nation’s right to hold international reserves in the form of gold, US dollar and other major currencies. In addition, lines of credit are available from the IMF. The reserves available and potentially obtainable set a limit on the cumulative size of a country’s balance of payments (BOP) deficit, thus acting as a BOP constraint in domestic policy making. But there is no such corresponding limit for surplus nations. The system is asymmetrical; it “punishes” those in deficit and lets the surplus nations alone.

Most countries experience some trade-off between unemployment and price stability. As unemployment is lowered by policies to expand demand (as with the US stimulative packages), the higher is the price that has to be paid in rising inflation. The trade-off varies over time, and from country to country. The rationale behind this relationship centres on the tendency for money-wage increases to outstrip rises in productivity even under conditions of high unemployment. The current state of a jobless growth in the US with low inflation in the face of continuing high unutilised capacity shows no trade-off at this time. But as demand picks up and as growth picks up and unemployment trends down, inflation is bound to creep up.

G-20 finance ministers and central bank governors gather for a group photo during the IMF and World Bank spring meetings in Washington on April 15. — Reuters

What’s wrong?

First, there is the adjustment problem. The present IMS has no reliable mechanism to eliminate BOP dis-equilibrium (ie payments imbalances). This is fundamental. There are three possible ways of correcting a payments deficit: use of trade and capital controls; adjustment of exchange rate; and government policies working through internal changes in income and prices. All three go against the the principles underlying the system. So, when a country experiences a deficit, there is no assurance the deficit will be eliminated before its reserves are used up; or depending on the extent to which market forces are allowed to sufficiently depreciate the currency; or whether domestic policies are tightened enough to reduce demand.

Second, there is the problem of the exchange rate, which usually doesn’t react fast enough to correct imbalances. Destabilising capital flows exacerbate the problem. The IMS is also subject to massive (especially speculative) flows of funds which could complicate BOP adjustment. The flooding of cheap US dollar funds into emerging markets following QE2 (2nd phase of Fed’s quantitative easing) have led to capital controls and managed exchange rates limiting their appreciation. Of late, the size of speculative flows has become too large for even the larger emerging markets to cope. This is not the end. In the event QE2 exits, the impact of large capital withdrawals on the exchange rate can be just as destabilising.

Third, there is the problem of liquidity. The system has no arrangement to generate in an orderly and predictable way, increases in foreign reserves that are needed to meet demands of growing world trade. The creation of SDRs (Special Drawing Rights) in the IMF, as and when needed, is supposed to do the job; but in practice, increases in SDRs have been few and far between. By chance, the Fed’s recent expansionary program, including QE2, is now over-doing the job; indeed, these capital flows have become too large for orderly adjustments to take place.



Finally, there is the confidence problem. The system allows persistently large surplus nations to do virtually whatever they please in postponing real adjustment. Today, about two-thirds of global reserves is held in US dollar-denominated assets (especially Treasuries). China’s international reserves today amounted to about US$3.1 trillion, of which US$1.15 trillion is invested in US dollars. It has been estimated that Italy’s entire sovereign debt (principal plus interest until 2062) totalled US$3 trillion. In terms of oil, China’s reserves can buy 25 billion barrels of Brent crude, equivalent to 13 years of its net oil imports. Indeed, it could pay for the entire Nikkei 225 list of companies, with US$30bil in change. That’s how big China’s reserves are.

True, the Bretton Woods system had served the world economy reasonably well. In a sense, the system operated well in the 50s and 60s but was on borrowed time. The “tearless deficits” during this period left a legacy of a large and growing “overhang” of foreign dollar holdings, which frequently threatens a confidence crisis. Persistent US deficits had since led to a diminution in the quality of the US dollar in the eyes of most foreign holders.

Global payments imbalances require a co-ordinated global action to resolve. This is hard to come by. Of the four problem areas, I think the matter of speculative and exchange rate instability is serious. This involves two aspects: (a) threat imposed by the “overhang” of convertible claims against the reserve currencies (especially US dollar) where such claims are today touching 15% of global GDP (6% 10 years ago); and (b) the danger of private speculative runs against currencies under pressure, especially the greenback. They are inter-related. To top it all, the IMF practice of allowing nations to choose their own exchange rate regimes didn’t help the adjustment process. Fixed exchange rates operated uneasily alongside flexible exchange rates, including managed floats and permutations of these two major regimes, in the hope that somehow policies would be co-ordinated to converge and foster imbalances adjustment. Nothing like it will ever happen as each regime did its own thing to protect its national interest.

And so, until today, the four problems of adjustment, exchange rate, liquidity and confidence underlying the IMS persisted. One thing is clear: there is no political will to reform. The US, for which reform means the diminution of the dollar’s global role, is lukewarm. And Europe is distracted more than ever with protecting the status of the euro and the EU’s sovereign debt crisis. France, as chair of G-20, wants to find an IMS that more accurately reflects the new structure of the world economy. But the major emerging nations, especially the BRICS (Brazil, Russia, India, China & South Africa) want to move away from a virtual one-reserve regime to one based on multiple reserve currencies.

Are payments deficits good or bad?

For most, payments deficits are instinctively bad. But think about it. After all, the purpose of international trade is to obtain goods and services from abroad at less than can be produced (or not available) at home. Imports are the benefits of trade. A trade deficit means more goods and services are being received from abroad than are being given up. Surely that’s good from the deficit nation’s point of view. But this deficit has to be financed. So, the nation either loses reserves (uses savings) or borrows (living on credit), and this may prove uncomfortable as the deficit persists. In the end, the deficit country has to take corrective action, such as deflationary domestic policies (austerity measures), exchange controls, or devalue its currency. All of them conflict with one or more of its domestic economic goals. There is a cost to adjust.

The soft solution is to use reserves (“its function is to render exchange rate stability compatible with freedom for individual nations to pursue national economic goals”). While drawing down reserves or borrowing may reduce the conflict of objectives, it nevertheless increases the potential for future conflict.

That’s exactly what’s happening in the US. It has run persistent deficits for so long that its debt is now too high (close to 100% of GDP) and its liabilities to nations accumulating US dollar reserves (especially China and Japan) have grown so large that it can trigger off a confidence run on the greenback.

This has proved inconvenient at a time when the US continues to need expansionary policies to bring down its high unemployment. Surplus nations have the opposite problem since these surpluses are inflationary and reflect an inefficient utilisation of reserves in the form of involuntary foreign lending. It can be viewed as the mere hoarding of resources that might have enhanced future output and welfare if added on to domestic investments instead. To sum up, today’s mixed exchange rate regimes provide no mechanism for systematic and effective BOP adjustment that does not conflict with major goals of public policy.

IMS reform

Reform of the IMS is clearly needed. V. Lenin once said that “the surest way to destroy the capitalist system (is) to debauch its currency.” The IMS is at the heart of the world economy. When rules of the global monetary game are unclear, inadequate, some even obsolete, nations find it difficult to play; indeed, some may exploit them to their advantage.

This undermines the very fabric of the IMS. Some history. In 1944, Bretton Woods gave birth to the IMF and today’s US dollar-centred IMS. The Bretton Woods conference was dominated by two strong-willed economists, H.D.White (US) and J.M.Keynes (UK). The UK wanted a system in which global liquidity is regulated by a multilateral agency (IMF), while the US (for self-interest) preferred a US dollar-based system.

Because of its enormous political power, the US got its way. Keynes, for all his intellect and persuasiveness, failed to: (i) endow the IMF with the power to create a new global reserve unit as an alternative to the US dollar; and (ii) secure a global regime which forces surplus as well as deficit nations, and the issuer of the reserve currency as well as its users, to adjust. It’s a pity as Keynes’ failures haunt us to this day. Nations with chronic surpluses (Germany, China and Japan) and the US as dominant supplier of US dollar reserves, do not face the same pressures to adjust their imbalances as do deficit countries that are often bullied to do so.

In my view, what is needed is a tripolar IMS organised around the US dolar, euro and RMB (China’s yuan or renmimbi). Let’s face it, neither the euro nor the RMB are in any position today to challenge the US dollar. The world will be better off with a viable alternative to the US dollar. Their interplay forces on the reserve currencies a market discipline earlier and more consistently. This way, central banks seeking to accumulate reserves will have a choice, so that the US no longer has “so much rope with which to hang itself” (so says my friend Barry Eichengreen). Another view is to transform the IMF’s SDRs into an international reserve currency (IRC). The trouble is, the SDR is not market tradable. To be an effective IRC, the IMF will have to be accorded the role of a world central bank. This is unlikely; indeed, a non-starter, as it was in the Bretton Woods days.

At the recent G-20 finance ministers meeting in Paris, all central bankers acknowledged that global imbalances remain a critical problem, and that a solution will involve policy co-ordination. Yet, each played down its own role. Until a solution is found, the “accumulation of foreign exchange reserves is a powerful instrument of self-insurance.” There is no political will to reform only the will to congregate and obfuscate. In the Bretton Woods days, the might of the US called the day. Today, it’s nobody’s call. What a pity.

Former banker, Dr Lin is a Harvard educated economist and a British Chartered Scientist who now spends time writing, teaching & promoting the public interest. Feedback is most welcome; email: starbizweek@thestar.com.my

Asian economies recalibrate to address inequality

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ASIA should have a smile on its face. The region's economy is displaying resilience in the teeth of a structural rise in oil and commodity prices. Overheating is a greater threat than a swoon in growth.

Yet the tone of some officials' recent comments has been strikingly cautious, reflecting an awareness that Asia has failed to seize the chance during the past decade of strength to address long-standing vulnerabilities.

Asia is still hopelessly dependent on final demand from rich countries. Investment, the seed corn of growth, remains far below levels scaled before the 1997-98 financial crisis, except in China and India.
Cross-border financial and monetary linkages are puny. Infrastructure, the sinews of every economy, is patchy. Asia generates less electricity than Latin America and has proportionately fewer phone connections.

So far, so familiar.

But policy makers are drawing increasing attention to another shortcoming of Asia's export-oriented growth model: inequality.

Disquiet over a widening gap between the haves and the have-nots was a factor in Singapore's election on Saturday, which ended in gains for the opposition.

And the urban-rural fault line running through Thai politics is in good part a rich-poor divide.

“There has been a significant increase in attention to inequality globally, and particularly in Asia,” said Xiaoqing Yu, the World Bank's lead economist for social protection in East Asia and the Pacific.

“Countries realise that inequality is contributing to social tensions and lost opportunities,” Yu said.
“Global events in recent months point to that,” she added, alluding to turmoil in the Middle East.

Even the International Monetary Fund, synonymous with stony-hearted austerity, has taken to stressing that “inclusive” growth is critical to the credibility of market-oriented reform and long-term development.

Inequality, up to a point, helps drive efficiency. But excessive inequality holds people back and stifles consumption. People cannot be expected to spend freely if they have precarious, low-paying jobs and scant social protection.



“It's really important for the region to continue to target more inclusive growth,” Anoop Singh, director of the IMF's Asia-Pacific department, said recently in Hong Kong. “It would not only reinforce stability, it would also help facilitate the rebalancing that Asia needs toward domestic demand and against simply an export-led model over the medium term.”

China is the best-known illustration of the economic and income imbalances spawned by such a model. Living standards on the seaboard, where export industries are concentrated, are many times as high as in the interior.

But South Korea is also counting the cost of a political economy geared toward supporting exporters at the expense of consumers and domestic service providers, according to Kwon Young Sun, an economist at Nomura.

The Korean economy recovered strongly from the 2008 global financial crisis, thanks to a largely undervalued won, huge fiscal stimulus and lower interest rates.

The ensuing increase in inflation and domestic debt penalised wage earners, while corporate profits rose as a share of national income.

The resulting widening in income inequality was one reason why the governing Grand National Party fared poorly in by-elections held on April 27, Kwon wrote in a report.

He said he expected the government to tweak policy in response, favouring consumers, smaller companies and lower-income families, rather than producers, big companies and rich families.

Other governments across Asia are also reacting. China is increasing health and welfare spending, while Hong Kong has just introduced a minimum wage. The Philippines is experimenting with a conditional cash transfer programme to help the poorest.

Yu of the World Bank said the 2008 crisis had brought home the need for a degree of social protection in a region where the umbrella of the extended family had largely substituted for public welfare.

“Even governments that traditionally have not put a lot of emphasis on poverty, inequality and protection now realise that they need some kind of mechanism, even if it's modest, to cope with a shock,” she said.
Of course, it will take more than a social safety net to temper inequality. As technological progress puts an ever-growing premium on skills, poorly educated workers are falling behind.

Here, the task for governments was to ensure a more level playing field by investing in skills development, Yu said, adding that Singapore, Australia and South Korea were showing the way.

In the grander scheme of things, nurturing a more equal, better-educated society will be critical if Asia is to avoid falling into the middle-income trap. This is when per capita incomes stall because countries fail to graduate from a reliance on resources and cheap labour to growth based on innovation and productivity.

South Korea has successfully made the transition. Malaysia and the Philip-pines are struggling to escape the trap.

If it avoids the trap, Asia would account for half of world output by 2050, up from 27% now; if it fails, the proportion will be about 32%, according to a report prepared for the annual meeting of the Asian Development Bank (ADB), held last week in Hanoi.

The report captured the prevailing circumspect mood, warning that Asia needed to address “daunting multi-generational challenges and risks.”

The ADB's managing director general, Rajat M. Nag, said the message was clear. “Your rise is not preordained; it is plausible, but you've got to earn it,” he said.

“You've got to make some policy decisions now to reduce inequity, increase the basic education, address issues of governance and corruption, show leadership and have strong regional integration if you are going to avoid the middle-income trap.” Reuters

New consumer mindsets

 Books Review by CHOO LI-HSIAN


Author: John Gerzerma and Michael D’Antonio Publisher: Jossey-Bass

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Spend Shift: How the Post-Crisis Values Revolution is Changing the Way We Buy, Sell and Live

IN their book Spend Shift: How the Post-Crisis Values Revolution is Changing the Way We Buy, Sell and Live, John Gerzerma and Michael D’Antonio show how consumers are “moving from mindless to mindful consumption” in an attempt to cope with their post-crisis loss of purchasing power and trust in institutions. In doing so, consumers are becoming “increasingly powerful and unpredictable”.

How they consume products is based as much on their emotional state as the environment around them. The book cautions that for companies “prone to celebrating a leadership position and a competitive market advantage, commoditisation may lie just around the hairpin corner.”

Consumers are resetting their spending and their lives to the new post-crisis financial realities. Through more strategic spending, consumers are voting for values with their dollars and influencing corporate behaviour. Communities are moving from capitalism to social collectivism supported by common values, a shared spirit of entrepreneurship and new skills in areas such as social media.

In response to this, many companies and brands are also making a very intentional effort to prioritise principles over profits, offering greater authenticity and creativity. At Walmart, Microsoft, Zappos and other companies, the authors met with executives who are applying new technologies side-by-side with old-fashioned customer-first practices to make their companies more relevant, resilient and profitable.

Stewards and staff of companies that are doing well by doing good ultimately also feel better about their positive impact on the communities they serve and the planet they share with their customers.

To tell the story of Spend Shift, the authors travelled from coast to coast, visiting large cities and small towns across eight American states to examine the value shifts sweeping the nation. They sat across kitchen counters, talked to small business owners and interviewed people from over 50 start-ups and large corporations. Their resultant efforts help readers to realise the depth and dimensions of the economic crisis and its consequences for American society and the world at large.

Marrying these real-life stories with solid research from Young & Rubicam, they analyse the changing consumer psyche, document the five shifting values and consumer behaviours that are remaking America and the world; and explain what it means to businesses and leaders. In stark contrast to the usual tired narrative of America’s decline, the book offers an uplifting alternative account of innovation, inspiration and surprising opportunity.

The authors introduce us to people who are reinventing their lives and livelihoods in the wake of the “Great Recession” that has “rearranged priorities, awakened creativity and reconnected us to the people and things that really matter.” We meet Torya Blanchard, owner of “Good Girls Go to Paris”, a tiny crepe restaurant that serves low-cost but high-quality meals in Detroit, a city where shuttered shops now outnumber those that are occupied.

There is Paul Savage, CEO of Nextek Power Systems, which champions electrical equipment made from direct current (DC) systems, Thomas Edison’s original creation.



We encounter Leslie Halleck, the first in her Dallas locality to start raising chickens in her backyard, who created a business to train other locals to do the same. Leslie stands as a shining example of how households across America are moving to more self-reliant lifestyles by shifting from consumption to production.

Through Cuban immigrant and Dallas librarian, Mariam Rodriguez, we discover how public libraries have become training centres for those who need to brush-up on skills, conduct a job search, or get free instruction in English as a second language. Library use in America has in fact reached record levels during the recession as people seek out education and community cheer. Sixty-eight percent of Americans now have a library card, the highest percentage ever.

We learn how technology and social media forums are helping to make generational and geographical divides disappear. The book talks of how senior editor of Make magazine, a bible for do-it-yourselfers, Phil Torrone partnered with Limor Fried to create Adafruit Industries, which sells kits and parts for original open-source hardware electronic projects out of a small loft in lower Manhattan. Adafruit sponsors “MakerFaires”, an online social forum where Millennial-aged electronics enthusiasts are mentored by retired engineers from NASA and Boeing.

The authors also reveal how Rob Kalin and his partners in Brooklyn created Etsy, an online place where artisans around the world could display handmade work and sell these to global buyers.

New business models with innovative incentivisation ideas have also emerged from the ashes of the crash. Partners, Lynn Jurich and Ed Fenster, solved the basic problem in rooftop solar energy that roadblocks many aspiring adopters – upfront cost. Her San Francisco firm, SunRun, gives homeowners guaranteed fixed energy costs through fixed leases for 30 years (that can be transferred to subsequent house owners) along with free maintenance with little or no investment; setting a fixed cost for power. SunRun’s customer base has increased by over 400% in 2010.

We speak with Andrew Mason, founder of Groupon, the group discounting phenomena that mobilises the masses with daily deals on products, services and even meals. The discounts are unlocked and activated when a threshold number of people agree to pay for the coupon or “groupon”. We see city council recycling manager Jon Norton working with RecycleBank to initiate the use of trucks mounted with scales and bins with electronic identification tags; so that the paper, glass and metal left on the curb by homes can be weighed and the households rewarded with shopping discounts.

In Western Massachusetts, locals have even created their own currency called Berkshares (named after the Berkshire Mountains) to help native shops survive competition from national chains moving into small mountain towns. Thirteen bank branches and community businesses have agreed to exchange these dollars to keep cash within the community.

The shift has not only been harnessed by small start-ups but also by the behemoths of big business. A case study shows how Scott Monty, head of social media at Ford Motor Co has moved the company toward openness and transparency. His goal was to start conversations with anyone who cared to speak to Ford. The Fiesta Movement on Twitter required that Ford actually allowed people to talk about the car in a way that was “unedited, uncensored, unscripted.” This new culture, coupled with new products designed through close counsel with customers and Ford’s refusal of Government bailout money, has helped to engender new respect and interest for the brand.

As the world economy struggles to find its feet after the last economic earthquake and its aftershocks, people are clearly coping by moving away from the material towards the more fundamental and the ethical. The book is vital reading for any marketer seeking to recalibrate their campaigns after the recession.

It provides a useful blueprint on new consumer mindsets and movements in the 2010s. It shows how businesses can adapt to the new consumer spending reality (more inquisitive, less acquisitive); repositioning themselves to appeal to this new sense of value tied to traditional values.