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Reform of monetary system

By Xu Hongcai (China Daily) Updated: 2012-06-16 11:48

IMF should build multiple reserve currencies including SDR and supervise their issuance and cross-border capital flows

Today, the most urgent task for the G20 is reform of the international monetary system. 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.

The outbreak of the global financial crisis in 2008 reflected the inherent vulnerabilities and systemic risks in the existing international monetary system. It has demonstrated that using a national currency as the global reserve currency is not suited to the world economy today, as the issuing countries of reserve currencies are constantly confronted with the dilemma of whether to achieve their domestic monetary policy goals or meet other countries' demand for reserve currencies.

The G20 should set up a permanent secretariat within the International Monetary Fund to improve its policymaking and implementation capabilities. 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 fully exercise its role and turn the Special Drawing Rights into a new international reserve currency. It should also supervise the economic behavior of its member states and provide an early warning system if there are any problems with any of them, as well as rescue economies in the advent of a financial crisis. Broadly speaking, the IMF should prevent systemic risk, secure global financial stability, and in particular, supervise the issuance of major international reserve currencies and the cross-border flows of international capital.

Meanwhile, it has become necessary to gradually change the current monetary system, which is centered on the US dollar, to a diversified international monetary system consisting of multiple currencies, such as the Special Drawing Rights, the US dollar, the euro and the renminbi. Reforming the international monetary system through the diversification of international reserves would permit the US dollar to continue to play an important role in the long term, but other currencies such as the euro, sterling, the yen, and the renminbi would play a greater role as international reserve currencies.

It is also imperative to include the currencies of emerging economies in the currency basket of the Special Drawing Rights and reform their adjustment and distribution. The IMF should make the currency basket of the Special Drawing Rights reflect the state of the world's economy accurately, and make the Special Drawing Rights 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 Special Drawing Rights for a broader range of activities and to start reducing the weight of the US dollar in the reserve currency system. In the long run, the Special Drawing Rights should eventually be used in international transactions, in domestic currency transactions, and become a reserve currency. The international community should also push for the internationalization of the renminbi to reduce the "burden" of the US dollar in acting as the reserve currency.

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

The first task is to build an international supervision mechanism for reserve currencies and to let the IMF take the responsibility for supervising the international reserve currencies. When an international reserve currency is devalued, the IMF can 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 in an open market. It could take a long time to build the Special Drawing Rights 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. During previous financial crises, the IMF has 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 Special Drawing Rights assets.

The fourth is to improve the collaboration and division of labor between the Bank for International Settlements 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 US and the EU together 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.

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 the renminbi will reduce the burden on the US dollar. Today, it is urgent to establish a competitive structure of "three pillars" that includes the US dollar, the euro, and the renminbi. In this situation, it would be a good idea to promote Special Drawing Rights as a global anchor, in order to realize a more stable exchange rate system.  

The author is deputy director of the Information Department of China Center for International Educational Exchange.

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