Breaking & Making an International Monetary System
Breaking & Making an International Monetary System
Way out of the Global Financial Crisis
Major parties struggling through the global financial crisis since 2008 now seemed to have seen some “light at the end of the tunnel”. U.S. economy stabilized and employment improved. Its Quantitative Easing (QE) tapering has gone from a screenplay to a show on broadcast, and entered into Season 4. Eurozone has witnessed mild recovery partly due to fiscal austerity. Yields of both sovereign debts and corporate bonds plunged abruptly in not only core nations but also peripheral states. What a boom it appears to be! Japan has shot the three arrows of Abenomics, the effect is not as loud as it sounds. Emerging nations seemed to have played the economic driving force at first, yet failed to sustain the momentum at the Finale of the Rebalance. Currency value plummeted as investors pulled their cash. This picture of the progression of this crisis is a bit of mess, missing some positive energy, though the major direction captured is just about right.
The U.S. economy’s way out is to print money, whereas the Europeans’ is to stall. The former sent banknotes all over the markets by QE 1 to n, while the latter started endless debt restructuring as a delaying tactic. Greece began its buyback. Spain is restructuring matured debts in order not to pay or pay less, while appearing less disgraceful or not at all disgraceful. Cyprus has their banks bailed-in to impose the losses on creditors instead of entirely on taxpayers. They are actually playing the same game, time for space, paper money to keep the capital running, both of which led to currency overflow and depreciation. Surely the USD with its anchor position provides a safe harbor. The more hazards out in the world, the stronger the USD becomes. However, do not be deluded by this illusion. No matter the exchange rate between any two currencies goes up or down, the real purchasing power of all major international currencies is going down. Paper money in circulation is losing credibility. Even if we could indulge ourselves for a moment in the bosom of USD, which would still be merely a safety bubble and would eventually burst.
Though it did not go with QE itself, China in parallel, has in its reserve an enormous amount of foreign exchange coming from major economies, hanging above its head like a Damocles Sword. New money needs to be issued to purchase the foreign exchange, which makes the money supply stay at a high level for long. Though being the core components of the monetary transmission mechanism, commercial banks are at the same time, bound by the mandatory loan-to-deposit ratio, and thus are unable to channel the new money into the real economy freely. Hence we see odd things as follows. Before June 2013, there was undersupply and high interest rate on the lending side, and at the same time abundant liquidity in the inter-bank market. After June 2013, the inter-bank liquidity fell short with surging rates while the capital chain in real economy remained tight and the funding cost stayed high. Starting from 2014, the money shortage eased in the inter-bank market, yet the financing cost is still soaring. The real economy still hasn’t found the measure to cover the lending shortage. Of course, some capital has found their indirect paths to flow into the real economy via inter-bank business and wealth management business, but the financial mechanism design in its nature, would inevitably result in financial intermediary’s dislocation and deviation from the real economy, leaving one side in water and the other in flames. Here is one more clarification to make. Do not take it for granted that the increase of lending is bound to cause reckless investment and overproduction, since what really matters is the price instead of the amount. As long as the lending interest rate accurately reflects the value of capital, the producer will then organize its production accordingly with careful consideration of projects, cost of labor, technology and other factors. The continuous increase in supply has pushed the money stock in China to an astronomical level. Even though the RMB appreciates nominally against USD or other currencies for now and maybe for a long time to come, its buying power as an universal equivalent and simply a means of payment for bread and butter, and production has gradually eroded away.
Europe is still struggling, U.S. is recovering and China is adjusting, however the monetary policies they adopted are the same in essence, no matter you call it QE, debt monetization, fiscal austerity, or proactive fiscal policy combining prudent monetary policy, and no matter the tools used are debt buyback, operation twist, central bank lending, or open market reverse repo. When the curtain is reopened for encore, all you see is just an ocean full of money bubbles. The problems right in front of us may seem to have gone for now, but just as the bubbles will eventually burst into nothing, what actually happened is that we simply swept our problems under the rug.
Where is the RMB going？Central banks all over the world have been in a money printing frenzy since the crisis took place, hoping to stimulate the economy with easy monetary policy. However, every choice has its consequences, and the worst scenario for this is hyperinflation. In theory, there is always a question of where and how inflation initiates and distributes. To put it in simple terms, those who can export inflation may relieve internal pressure, and those who are forced to take in inflation will become collateral damage. This is a game of drum-and-pass. The U.S holds the drumstick in its hand and will send the flower to anyone at any point that serves its best interest. Let’s take a look back at the financial history. The 1997 crisis started in Southeast Asia spread to East Asia in 1998; India and Indonesia started to suffer from capital outflow and currency depreciation exactly the same time when the U.S. and Europe saw their twilight in 2013. We can’t help but wondering, will the crisis this time again be led to East Asia in 2014? One may still remember that Chinese government promised not to devalue RMB back then, and now it promised, with clenched teeth, not to let the economy take a hard landing. A reform is like a house renovation, painting, flooring, breaking down the old things to make it new. The excitement of the new may for a while be able to justify the necessity and righteousness of the reform, but don’t forget that this comes with a price. The hope we had for the reform was to bring in foreign capital, technology and mechanism to facilitate domestic economic transformation and subsequently social transformation. However, the foreign rational economic man remains sensible as usual. They are coming to this New World to seek excess return out of the huge market potential, leaving the natives come to realize at the end of the day, that they have to bear the cost on their own. Clean environment, labor force, land and rent, multiple times of factors of production have been thrown into this trade for glamorous GDP growth. Who is there to pay for all of these? The government, public, private sectors, or each of all has to share. Then there comes the question of how. The answer is RMB devaluation, particularly the weakening of its real buying power, possibly deep depreciation, with inflation on the other side of the coin. This certainly cannot be regarded as the best solution, hardly a satisfying one. The negative impact will become more significant along the progress of RMB’s internationalization. The prognosis of RMB trend underlines the importance to recalibrate the money supply mechanism. RMB internationalization should be based on independent, well-targeted and forward-looking monetary mechanism, rather than following the herd. At the heart the rule-based principle must be upheld, the foremost being discipline and responsibility.
Way into a Functioning International Monetary System
The Bretton Woods System established the anchor position of USD, as a result of the wrestling between the Keynes Plan of U.K and the White Plan of the U.S. The fight between Keynes’ Bancor and White’s Dollar was in fact a power display of Sterling Pound and USD. The U.K. wanted to de-dollarize, and the U.S. wanted to substitute for the gold standard. The outcome needless to say, is that the Bancor and its virtual world government gave in to the U.S., the strongest real-world government. This demonstrates to us that international currency status and monetary system are not a pure competition of financial strength, but the comprehensive contest of political, military and diplomatic power. Later, the dollar-based gold exchange standard under the Bretton Woods System evolved into the Jamaica System which is described as a system of no system, the essence of which is a coming back from the fixed exchange rate system to the floating system even with various fixed alternatives. This is the so-called disappearance of trace of savageness in gold, and the reconstruction of a fiduciary money system.
Both the Bretton Woods System and the Jamaica System are built on faith in credit money. A fixed exchange rate system may be stable, yet it will inevitably stuck in the Triffin Dilemma and is no solution to the confidence issue of credit money, due to the unbalanced economic and political situations. The floating rate system on the other hand, does in pace with the unbalanced reality, yet its cycle of crisis-reconstruction-more crisis-more reconstruction shows that the confidence issue and exchange rate instability is still outstanding. Unbalanced development, relative stability of exchange rates and the faith in credit money still pose themselves as the impossible trilemma.
Fundamentally speaking, the core of a fiduciary money system is creditability of credit, of which confidence comes from, and it can only be established through prudent arrangement from an effective international coordination mechanism, backed by self-discipline of all participants. The two pillars referred here are:
First, discipline, which means that no country should monetize its debt and deficit at liberty. Both the public debt to GDP ratio, normally less than 60%, and the deficit to GDP ratio, normally no more than 3%, should be controlled within a reasonable limit. And this should be made into a mandatory requirement and executed with utmost rigour. The U.S., Europe and Japan have turned their post-crisis efforts into a contest in public debt and deficit monetization, and almost all of these two ratios went beyond the limits. Consequently, while the market malfunction remains severe, the government malfunction is also on the way.
Second, responsibility, which mainly refers to the money supply to GDP ratio. The money supply should in line with the GDP growth, industry structure, maturity level of financial system and social financing structure. Value of money and quality of economy shall not be sidelined. Currency issuance may seem to be one country’s own decision, yet indeed it matters significantly to all that under the international monetary system and specifically the international coordination system. If a nation supplies money just to stimulate its own economy, that may work to its own advantage in the short-term, but will certainly cause chaos in global market.
Discipline and responsibility are the necessary and sufficient conditions for the building of a functioning international monetary system. Their effect will first show internally and then extend to the external, the feedback of which will later come back to the internal. The international monetary system can only be stable and firm with these two pillars in place. Looking forward, we may consider center the system on IMF’s SDR or we may continue with the progression of the current monetary system with USD at the core and gradually transform into a real multiple-currency basis. One thing I can speak for sure is that RMB will definitely be a crucial and organic part of the international monetary system, and that the RMB will complete its internationalization as a settlement currency, investment currency and reserve currency step by step. Most importantly, this process should be completed with utmost discipline and responsibility.
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