“How to eradicate the Triffin dilemma which remains the major causeof the global macroeconomic imbalances?”

Christian GhymersIRELAC-ICHEC

Brussels

"…a [foreign] credit system… when the debts under it go on increasing indefinitely and yet arealways liquid for the present (because all the creditors are not expected to cash their claims atonce), is a dangerous money power. This arrangement…constitutes in fact, a treasure for thecarrying on of war…and it can only be exhausted by the forth coming deficit of the exchequer –which may be long delayed by the animation of the national commerce and its expansionistimpact upon production and profits. The facility given by this system for engaging in war…istherefore a great obstacle in the way of a perpetual peace. The prohibition of it must be laid downas a preliminary article in the conditions for such a peace, even more strongly on the furtherground that the national bankruptcy, which it inevitably brings at last, would necessarily involvesin the disaster many other States without any fault of their own…Consequently, the other Statesare justified in allying themselves against such a State and its pretensions."( E. Kant, 17951)

1. Introduction: purpose of this paper

The global crisis which started to hit our economies 7 years ago is about tosettle for long, exposing our social systems and democracies to worryingthreats as much as the political leaders remain unable to understand somebasic macroeconomic realities.

The amazing thing is that nothing in this crisis is neither new nor shouldhave even been unexpected, contrary to most of the observers use to repeat.

In the aftermath of the world financial crisis most of the attention hasshifted towards financial sector reforms and a large number of economists isconsidering the lack of adequate regulations as the mayor cause of thiscrisis. Although it is clear that micro-regulation failures played indeed asignificant role in the world crisis, these fundamental weaknesses cannot hidethe macro-monetary framework in which the financial activities develop their

1 Immanuel Kant, Perpetual Peace: A Philosophical Essay, Translated with introd. and notes by M. Campbell Smith. With a pref. by Professor Latta, Published by Swan Sonnenschein, London, 1903 extract from section 1, Preliminary articles of Perpetual peace between states, Article 4: "No National Debts shall be contracted in connection with the external affairs of the State".

1

products and shape their behaviors. This macro-framework presents itself apeculiar deeper defect which is not yet tackled in spite of having beendetected since more than half-century ago by Robert Triffin (and progressivelyby some other economists): the asymmetric nature of the International MonetarySystem which is mainly based upon the US$ as the international reservecurrency i.e. a national currency. Indeed, as repeatedly explained by Triffin,the contradiction among national and international requirements doesinevitably lead to global imbalances and destabilizing international monetarywaves. It is time to wonder why the question of the possible links betweensuch an asymmetry in the global macro-framework, the resulting globalimbalances and the persistent global crisis has not yet been focused ortackled. Economics, as other disciplines, does not escape paradigms andintellectual biases, but in the future History will judge with severity thestrong responsibility our economists' community bears in this amazing failureof rationality. This is a paradox for a profession which pretends to advocatefor a simple rationality but continues to be unable to adopt a rationalapproach in the basics of the International Monetary System for the sake ofcommon interest and global welfare.

While it is true that financial deregulation, leveraged speculation and shadowbanking are an intrinsic part of the chain of evils which characterizes theglobal crisis – as acknowledged by all the economists now – this contributionadvocates for extending the analysis to what could be the most importantcausal mechanism of this crisis and which relies upon deeper but simplermacroeconomic roots: the International Monetary System (IMS), in fact an“International Monetary Scandal” - as coined by Robert Triffin more than threedecades ago.

In our view, extrapolating the Triffin's dilemma allows for understanding thatthe inability to manage rationally the global monetary liquidities can explainthe endogenous nature of the world credit-boom which led to the global crisisand which is continuing to feed frightening global imbalances. The persistentimbalances continue to expose the world economy to financial instability andat any moment could spark a confidence crisis in the US $ which has thepotential to trigger a sharp adjustment with severe consequences uponinternational trade and economic growth. The financial deregulation thatallowed for the over-leverage, over-indebtedness and excess of risks is only atransmission/amplification mechanism but it is not by itself the origin of thecrisis. Therefore, any action for improving the functioning of the financialsector would not get its full efficiency and impact without dealing also inparallel with the macro-defects of the system and its fundamental instabilityresulting from its inner asymmetry.

2

The specifically monetary factors upon which the crisis relies have not yetbeen afforded the attention they deserve, especially the so-calledInternational Monetary System (IMS) in which monetary policies have beenworking since more than six decades. Although under the frightening fall ofworld activity and trade in 2009 some politicians had issued some earlydeclarations for reforming the IMS and the financial architecture, these easy-words do not seem to be followed neither by structured ideas nor by effectiveattempts to tackle the IMS problems. Except for the initiative taken by thePresident of the UN General Assembly in 2008 to charge the Stiglitz commissionto issue a special report in 2009 on Reforms of the International Monetary and FinancialSystem2, among policymakers and official institutions there were no significanteffort (beyond political discourses) to make other proposals than merefinancial regulations and traditional monitoring. It is amazing that neitherthe EU nor the IMF and G-20 economists are looking seriously towards thesemonetary factors and their specific roles before, during and after the crisis.To overlook these monetary factors upon which precisely the G-20 (and EMU)authorities have a say prevents from understanding exactly what has not beenworking well and even more worryingly, it would prevent policy makers frombeing able to escape a new disaster which would be already in preparation bytheir fault.

Indeed, the present IMS continues to work with and to rely mainly upon the US$ - a national currency - as the key international currency, which makesincoherent and unstable the world economy by creating spillovers and bigmonetary waves and. The only rational and democratic solution is to build amultilateral reserve currency upon the existing SDRs and IMF by upgrading theSDR unit-of-account to a genuine Multilateral currency issued by a morerepresentative IMF empowered to regulate the global liquidity with technicalrules. This option is not new as it is merely an adapted extension of the oldKeynes/Triffin proposals. The first one was conceived by Keynes even beforethe second-world-war and elaborated in 1942-44 as the British Treasuryproposal presented at the Bretton Woods conference and rejected by the USauthorities. The second one was shaped by Robert Triffin in the late 1940s andin the 1950s in order to correct the Bretton Woods system from its majordefect. Amazingly, in spite of some academic efforts, it is not yeteffectively present in the main debates about how to improve the IMS in orderto tackle the causes of the global crisis by making it more symmetric. Thelack of rationality of the dominant policymakers, IFIs and most of theeconomist corporation remains inexplicable and shocking.2 The final report was adopted by consensus by the 192 Member States of the General Assambly of the UN. See link http://www.un.org/ga/econcrisissummit/docs/FinalReport_CoE.pdf

3

Therefore this paper tries to propose - in parallel to a few other academicattempts - to bring into the official agenda of concerns the fundamentallogical mistake in which the present system is trapped and to contribute tobuild a practicable path for escaping the insane asymmetry of the $-systemwhich reflects a lack of rationality. Although the basic principles forevolving towards more symmetry are not new (but have to be repeated again),the operational method - which is proposed in this paper for implementingprogressively a new IMS able to provide the tools for stabilizing the globaleconomy - is more original (although very Triffinian) and relies on somepragmatic experiments made in Latin America and other regions. It consists indeveloping regional monetary arrangements in LDCs able to provide thecooperative basis for building regional consensus giving an effective say toLDCs regions - or a lever for involving better the EU and the biggest emergingeconomies - in the multilateral order. This method based upon an effectiveinclusion of those who are the most affected by the present globalinstability, offers an orderly way to break the irrational status quo of the $standard at the lowest costs and in a global win-win game in the bestinterests of all and especially of the US economy.

2. The key-issue of the IMS

It is worth to start by going back to the most basic elements whichcharacterize any IMS. This is the most pertinent question which has to beraised for understanding the global crisis and how to get out of it: in factthe answer is that an IMS is a way to solve the coordination problem arisingfrom the existence of “n” different currencies and sovereign policyauthorities in presence of clear spillovers between them which overlap theirautonomy. Unless these spillovers are explicitly acknowledged and channeledthrough cooperative or centrally managed arrangements, they imply negativeimpacts with significant costs for individual members as well as for the worldwelfare. Rational attitude would imply that the “n” actors would cooperate fororganizing their relationships in order to maximize the net result of theirseparated actions. However, uncertainties about the “real model” combined tolack of communication and reliability between players (lack of trust forsharing the costs and benefits among autonomous actors) block them in atypical “Prisoner's dilemma” situation i.e. non-cooperative attitude leadingthem to a negative outcome for all. There are only two alternative logicalsolutions: either transferring national sovereignty (centralization ofdecisions or abandoning it to a Hegemon) or sharing it through a reliablecooperative scheme fixing some rules by ensuring a previously agreed burden-sharing. This latter modality applies the “subsidiarity principle” by limitingthe constraint upon national sovereignties to an agreed framework of

4

principles. In fact, this option allows for preserving or even increasing ex-post national sovereignty as the collective win-win game resulting from theex-ante binding commitment makes up for the initial self-limitation in thediscretionary room for maneuver at national level.

In a world segmented in national currencies and without (n+1)th currency it isnot a surprise that decentralized policy choices are potentially conflictive.There is therefore a case for (at least trying to) channelling these conflictsthrough a set of global rules i.e. a genuine system either for coordinating"n" different monetary policies and reciprocal external adjustments (i.e. forrestricting national policy sovereignty through an unrealistic supranationalpower) or more subtly for creating again the missing neutral "n+1" currencyfor restoring more symmetric forces able to constraint automatically the setof "n" monetary policy stances (i.e. limiting also national policy sovereigntybut through an automatic self-constraint which needs considerably lesssupranational institution and without transferring any monetary policysovereignty). Indeed, there exists a logical possibility to make individualchoices compatible and optimal directly through compulsory world governance orindirectly through the creation of an additional specific adjusting agent -the "n+1th" one - issuing the international currency. This latter alternativeis à-priori the more realistic one (or the less difficult to agree upon)because it is the more “subsidiary”. It consists in charging this "n+1th"agent to validate the net result of "n" policies upon world liquidity demandfrom the "n" autonomous choices under only the global constraint of a nominalanchor able to ensure world price stability. This nominal anchor - or globalconstraint - represents the need for a global monetary policy stancecompatible with international price stability and stable macroeconomic growth.

This paper attempts to make the light upon this fundamental governance issueby a pedagogical effort for identifying the main components of the issue. Thefirst step is to address the main functions of the IMS which need to becoordinated and which inner issues it is supposed to tackle.

3. What is an IMS?

“System” implies the existence of an agreed and structured way for organizinginternational payments across “n” different currencies. This means there is aneed for organizing the way to fulfil simultaneously two main stabilizingfunctions:

1. providing adequate liquidity for meeting fluctuating levels of trade,economic and financial activities at global level without creating sharp

5

world monetary business cycle (i.e. preventing international waves ofexcess or scarcity of international currency)

2. providing means or tools for correcting smoothly global imbalances i.e.warranting that adjustments of balance of payments imbalances do nothave major global repercussions; this means ensuring symmetricadjustment or at least without creating a net contraction in the globaldemand and preventing national aggressive measures that could createconflicts/unfair practices damaging for trade and capital movements

It is important to realize what Keynes formulated clearly in the thirties(under the clear influence of the global depression): adjusting externalimbalances is inherently asymmetric and deflationary as it creates arecessionary pressure on the world economy. Indeed, adjustment tends todepress world demand because the constraint upon deficit countries to balancetheir account is stronger that the willingness of surplus economy to adjustvoluntarily by deciding to save less (especially when uncertainty is high orwhen deficit financing dries out in global recessions). This basic feature ofthe working of the international economy makes crucial to identify the mutuallinks between the play of these two above functions, the first oneconditioning the second one while the second one cannot put at risk the firstone.

Therefore, fulfilling efficiently these 2 functions means to provide thisessential Public good which is world macroeconomic stability, a preconditionfor ensuring a sustainable growth. This requires in turn the collectiveconstruction of a set of coherent international rules, tools and institutionsi.e. a genuine structure of public intermediary goods agreed legitimately uponat multilateral level.

The fact is that the existence of a plurality of national currencies undersovereign authorities makes these two functions especially complex to befulfilled efficiently. The IMS is indeed characterized by a specific issue.

4. The analogic specificity of the IMS issue with any national monetary system: the redundancy issue or the “n-1 degrees of freedom”

The very basic issue any IMS is supposed to tackle is the automatic - andspecific - interdependency which results from the over determination createdby the existence of “n” different national currencies which are mutuallytraded. In order to make clearer the existence of a specific need for enablingthe IMS to solve the over determination resulting from the national currencysegmentation, let's consider the analogy between the international monetary

6

system and a national monetary system: in the IMS, there is the same need forpayment settlements across central banks (or countries) exactly as it doesexist and has been solved inside a domestic economy across its commercialbanks (or other national agents) since national Central Banks were created.Inside an economy like the US economy with a single currency issued by asingle Central Bank, the Fed, which controls the global $ supply forsettlements across its banks and its local “states”, the imbalances betweenbanks and states are equivalent to balance of payments disequilibrium betweencountries. In this single economy, these disequilibrium registered betweenbanks (and regions) tends to adjust automatically by the transfer of $liquidities (the national single reserve currency for the banks) from one bank(or region) to the others inside the country. Inside an economy, such anautomatic adjustment does not create logical problem and is supported by thefull freedom of circulation for production factors (labor, capital and firms)while national government transfers (social security and other subsidies)could cushion part of the activity consequences of these internal liquiditychanges.

On the contrary, in a world with “n” sovereign independent monetary powers,the existence of “n” national monies provides for alternatives since eachsovereign monetary policy introduces at state level another tool whichinterferes with and could even oppose to the adjustment process. However,these individual rooms for maneuver (at state level) introduces a specificproblem at the collective global level which requires an explicit treatment:with n different currencies there exist only n-1 “degrees of freedom” i.e. "n-1" feasible independent national policies, n-1 exchange rates and n-1 current-account balances. ). Indeed, there is only one exchange rate between twocurrencies and when the US spends more than it earns, the Rest of the Worldbecomes inevitably a net saver making automatically loans to the US economy,alternatively when China wants to save (much) more than it invests, the Restof the World becomes mechanistically the debtor of China. How to adjustimbalances and exchange rates? This introduces a redundancy issue for nationalpolicymakers at world level: they can only decide freely the content of "n-1"domestic policies i.e. the autonomy of individual monetary policies isrelative and limited by the existence of the autonomic decisions of theothers.

Therefore, in the case of “n” different currencies, the adjustment ofimbalances is not anymore automatic contrary to the national level acrosscommercial banks or regions using the (limited) Central bank liabilities assettlement tool (the monetary base or the Central-Bank money), and alsocontrary to the international level when the physically limited stock of gold

7

was used as the single international currency reserve. In the national analogybefore the invention of Central Bank the same redundancy issue existed betweenthe several banking currencies issues in competition by national depositbanks. The specificity introduced by the national Central Bank – and which isstill missing in the present IMS - is to provide a “neutral” additional agent– the (n+1)th agent - able to adjust its own liabilities for providing theliquid reserve standard needed by the “n” deposit banks for backing theiractivities. Such a (n+1)th liability is therefore above the “n” currenciesissued by the “n” deposit banks by its inner “liquid reserve” nature whichprovides the reliable liquid asset commercial banks require for clearing inconfidence their mutual payments. At the international level, the idea ofusing a “non-national” currency as the single reserve currency accomplishesthe same function as the national monetary base issued by the national CentralBank. Therefore it introduces the missing (n+1)th currency (like gold in thepast gold-standard) which gives the missing nth degree of freedom for imposingautomatically the compatibility between the “n” independent monetary policies.Such a (n+1)th currency anchors automatically the n national monetarypolicies.

In the case of a single reserve currency for the world – like it used to beduring the time of the gold standard before World War I or like it could betomorrow if a new multilateral reserve currency would appear – the “n”monetary policies are constrained by the availability of this "n+1th”international currency: an adjustment mechanism would automatically counteractthe net savings (current-account) disequilibrium through the macroeconomiceffects of the respective monetary base transfers resulting from – for example- the US deficits and Chinese surpluses. This is not the case in the presentIMS.

In fact the above macro-monetary aspects and mechanisms share exactly the verysame logics observed at national level (into any single economy) between thepotentially conflicting choices of its “n” different economic agents (or localbanks) with respect to liquidity (demand for money): the n agents havedifferent positions with liquidity, some are spending more than they earn(agents in deficit accumulating liquid debt), others spend less (agents insurplus accumulating liquid assets against those in deficit). If the deficitagent 1 is big and credible winning so the privilege to make its own debts tobe used as a payment assets across its creditors, it can use to pay by issuingmerely its own checks (liability at sight, perceived as perfectly liquid). Thereason is merely that the "n-1" other agents accept to use these checks aspayment mean in the economy and as a result find convenient to hold more ofthese universally accepted liquid assets as "liquid reserves". But by piling-

8

up more and more checks issued by "agent 1", this demand for money by "n-1"agents makes "agent 1" to become a growing debtor with respect to the "n-1"others. In this system, since the liabilities of one agent are used as themain payment and reserve currency, spending behaviours become asymmetric:"agent 1" is the only one which does not face any liquidity or financialconstraint contrary to the "n-1" agents. However both groups find converginginterests for maintaining the system running: “n-1” agents must accept theoverspending behaviour adopted by "1" as far as they want to pill up moreassets upon “1” by under spending at home. Nevertheless, this convergence ofinterests and goals creates more polarizing imbalances without any adjustmentincentive. This tends to push to an excess of money creation. Historicaldevelopment have clearly shown that it was preferable to transfer theassessment and regulation of monetary base creation to a neutral agent whichis neither the creditors “n-1” nor the debtor “1”. This is not just commonsense; it is overall because the need to create sufficient volume of trustyreserve currency cannot be limited by the net position of a common economicagent. Only a specific agent created for clearing payments across banks - andtherefore placed above the others by this function - can efficiently ensurethe public good of adequate liquidity creation. The argument comes simply frombeing the “n+1”th agent above the “n” others composing the economy: its ownliabilities held by these “n” agents of the economy are issued by definitionagainst assets upon (or sold by) the same “n” agents for exactly the samecounter value. Therefore, the growing trend of issuance of monetary base -contrary to the issuance of banking money by a commercial bank - cannot implya growing net liability for the Central Bank.

In the past, at national level, private banks used to issue paper-monies incompetition as circulating currencies. Recurrent confidence crisis made thiscompetition pro-cyclical, unstable and actually costly. Liquidity ispotentially conflicting at collective level, especially with cyclicalfluctuations changing endogenously the degree of available liquidity basedupon confidence. This is why the National Central Bank emerged as the “lenderof last resort” or as the institutionalization of an additional neutral agent(the n+1th) with respect to its availability to issue its own liquidliabilities as the institutional mean of payment. Its specific function is to“validate” the net result of the "n" different demands for money (in factassessing the opportunity to validate or not these choices for ensuringstability i.e. preserving the public good function through its stability-oriented monetary policy) by issuing or destroying passively its own liquiddebt in function of the stability objective i.e. public interest and not itsown interest as individual issuer. In counterpart, this perfectly liquid

9

liability is used precisely as the only vehicle asset by "n" agents in thedomestic economy because the Central Bank is different from any other agentsolving so the redundancy problem at national level: it is conventionallyagreed to use the liquid debt of this "n+1" agent as the universally acceptedmeans of payments by the "n" other agents. Contrary to the use of theliability of one of the "n" agents, this new "n+1th" asset/liability cannotissue net debt with respect to the existing "n" agents since these agents holdit as an asset upon the "n+1th" one (their central bank) which in turn holdsin counterpart an equivalent amount of assets upon the "n" agents of theeconomy and upon foreigners agents.

5. The most amazing paradox in Economist Corporation

Reminding so elementary aspects of money could seem too elementary to economicanalysts but we are obliged to realize it is not at all the case. Indeed, forunderstanding what Triffin qualified as "the incomprehensible lack of awareness of[asymmetric] defect by virtually all economic analysts"3 of the IMS, it is essential tocapture from the beginning that as money is first of all a liquid debt of anagent (or an economy) it must be issued by an additional agent which is"multilateral" with respect to the "n" agents (economies) and not by one ofthe "n" competing ones (economies) the debts of which would increase with theneed for (international) monetary reserves, creating an inner asymmetrybetween this "nth" agent and the "n-1" others. This is true both at nationalas international level and allows for managing rationally the monetarycreation process either domestic or international. At national level, themonetary base may expand without creating asymmetry as far as this liquidliability is issued against corresponding assets: the apparently tautologicalbalance-sheet equilibrium means that a Central Bank cannot incur into net debtposition when it issues monetary base. Transposing it at the internationallevel, it means that by definition there is no net foreign asset (orliability) for the issuer of the international currency as far as he remainsmultilateral. The global monetary base may expand as far as necessary withoutcreating directly any net debt and without worsening any internationalasymmetry or sovereign imbalance since it is issued along the same balance-sheet equilibrium principle: by definition there is no net liability or assetworldwide, liabilities being pilled-up not against an individual economy butagainst the global system itself and as the counterpart of equivalent assetsheld on the asset side of this system. Therefore the "n" participants to the

3 Triffin, Robert, "The IMS (International Monetary System…or Scandal?) and the EMS (European Monetary System…or Success?)", Jean Monnet lecture, EuropeanUniversity Institute, Florence, Banca Nazionale del Lavoro, Quarterly Review, n°179, December 1991

10

system face all the same liquidity constraint. It looks a stupid tautologybut it is rather the attractive principle of a clearing union that backs theKeynes/Triffin4 proposals for a symmetric IMS that most economists do notactually realize. If they would understand it, they would immediately agreeupon the urgent need to shift from a key-currencies system to a multilateralreserve currency.

It is especially amazing that on one side contemporaneous economists5 do fullyagreed at national level upon the need to create a “(n+1)th agent above all the othersbanks” for ensuring this Public good that the markets were unable to organizespontaneously, while on the other, most of them are still unable to agree uponthe need for the same kind of solution at world level in spite of beingconfronted to exactly the same redundancy issue (the issue of “n-1 degrees offreedom”) and to the same need for a systemic supplementary agent - the (n+1)th - which could only be public and multilateral for being above all thecountries in order to pursue global stability goal and symmetric adjustment.The conflicting logics of the "n-1" degrees of freedom makes fully natural andrational to look for establishing an institutionalized consensus atmultilateral level (i.e. worldwide neutral) for fixing a nominal anchorcombined with an issuance rule for optimizing the issuance of liquidliabilities which are needed for supporting both sustainable real growth andsmooth adjustments.

This systematic inability of economists and policymakers - observed during thelast hundred years - means they refuse to acknowledge there is a need totackle the very basic issue of the “n-1” degree of freedom or the mechanicalspillovers of any national macroeconomic development which implies an oppositechanges in the Rest of the World. This implies the strong conclusion thatapparently rational economists at national level – at least the huge majorityof them – become dangerously blind and irrational when dealing with theinternational level. In a world engaged in an accelerating process ofglobalization this sounds as a worrying contradiction that makes clearEconomist Corporation are trapped by non-scientific attitudes and irrationalbias much more than what they are able to be aware of.

4 5 One notable exception in the XXth century was Friedrich von Hayek (1899-1992) - Nobel Prize 1978 - who was advocating (at the end of his career) for a purely private banking system in which customers could choose from among private competing currenciesfor ensuring the more stable purchasing power. See Denationalization of Money. London: Institute of Economic Affairs, 1976. It seems that no successor develop this extreme position. More recently, with the emergence of the bitcoins, similar suggestions appeared again.

11

This is all the more a shame for a profession well known for its pretentiousrationality, that the inner logics and purpose of any IMS is precisely to tryto solve the “n-1 issue” as they generally pretend to know. For example thefamous “Gold standard” which ensured price stability during the 19th centurywas based upon the “obvious” acceptance of a (n+1)th currency (Gold) forestablishing “n” degrees of freedom making coherent a system of relativeprices (or exchange rates) without losing global stability. Also, the failureof the Bretton Woods system which tried to by-passed the nth agent by using anational currency as the international standard is universally acknowledged.However, the failure of the floating regime for restoring the nth room formanoeuvre is not yet acknowledged by the Economist Corporation. This confirmsthe lack of awareness of the existence of systemic monetary policy spillovercreated by the present dollar system.

The gold standard formula was (rightly) rejected for two major reasons: firstfor making the issuance of international reserve dependent upon non-optimalcriteria (in fact from random mining/geographical factors), and second forensuring external stability at the expense of domestic activity stability(contractionary bias of the adjustment mechanism as far as deficit countriesare more severely constrained to adjust than surplus countries). When thesetwo major defects were dealt with at the Bretton Woods conference in 1944, theKeynes' plan for solving them through the creation of a multilateral currencywas unfortunately rejected, opting rather for entrusting the US $ - a nationalcurrency - for playing the role of the main international currency. Thisdouble role given to the dollar was however contradictory and therefore unableto solve satisfactorily the redundancy issue. It corresponds to a move from asystem with "n+1" currencies (the old gold-standard) to a system with only "n"currencies (the present dollar standard) losing thus one degree of freedom andshifting de facto the anchoring of the system to the discretionary hands ofthe Fed, a national central bank.

6. Revisiting the Triffin dilemma: the missing (n+1)th currency leads to a contradiction which impedes an efficient anchoring of the monetarysystem

As coined first by Robert Triffin with his famous dilemma, the dollar systemwhich has been prevailing since Bretton Woods implies only two possibleoptions: (i) either the US economy validates (passively or trying to stabilizeinternational price levels and not the domestic ones contrary to its legalstatuses) the n-1 choices made in the rest of the world; this means abandoningany domestic policy objective for responding to the demand for reserves of therest of the world by expanding endless its liquid liabilities – or (ii) the US

12

maintains its own domestic policy choices or fears the over-indebtedness ofits economy implied by answering passively to the international demand forreserves in dollar; this option would give priority to domestic purposes atthe expense of the global ones, creating inevitable conflicts and costlysuboptimal outcomes.

Whatever the chosen trade-off between the alternatives of the Triffin dilemma,inappropriate global waves of monetary expansion or contraction do resultbecause the dollar remains the dominant key-currency which also plays the roleof “relative” anchor of the system. Indeed, although all the currencies wereinitially “anchored” to the dollar through the fixed-but-adjustable parityregime of Bretton Woods, the dollar itself was without any explicit anchorrule but the initial symbolic link to the gold at a fixed price of $ 35 perounce. As facts showed, this link was not very effective, in spite ofdiplomatic pressures first, and then by the pool of gold, which was de factobypassed in 1968 before the official end of dollar convertibility in gold in1971. After the collapse of the peg-regime, the formal absence of systemicexternal anchor was officially made up for by domestic monetary rules(external stability was supposed to result from domestic price stability). Asexplained in boxes 1 & 2, the Triffin dilemma survived Bretton Woods I 1944-1971 with continuation of the use of the dollar as the main key currency whichhas maintained the inner contradiction between domestic and international roleof this key-currency, worsening the absence of systemic anchor provide by theSMI.

BOX 1: The Triffin dilemma, its persistence after Bretton Woods and the remaining “exorbitantprivilege” given to the US economy

In an international monetary system which uses a national currency as a standard for payment andreserves, the creation of international liquidity to meet the global demand for reserves is done through apermanent increase in indebtedness of the country that issues said currency. The dilemma thus translatesinto the basic contradiction that exists between ensuring the credibility of the currency, and allowing it tofulfil its role as international currency, which inevitable leads to the destruction of the intrinsic qualities(that justified its selection as international standard) since it is forced to accumulate endless foreignliabilities. Therefore, the alternatives for this dilemma in the economy issuing this key-currency are eitherto opt for sustainability, which causes a global deflation due to a lack of liquidity vis-à-vis its foreigndemand, or to meet a global need, which dooms the issuing economy to destroy its own credibility(however necessary for backing its role as an international standard).There is an irremediableincompatibility between the global objectives (and needs) of the US$ as the key-currency, and thenational objectives (and needs) of the fiscal and monetary policies of the country issuing the currency.

13

This incompatibility explains the downfall of the Bretton Woods fixed-exchange-rate system (1944-1971/73). However, the flexible-parity system that replaced fixed parity has not solved the dilemmaeither: the dollar is still the main international payment instrument, which means a permanent demandfor reserves in $ allowing the US to benefit from a resource transfer by issuing more liquid liabilities i.e.an asymmetry making easier or automatic external financing for the US economy thus perpetuating thedilemma and the “exorbitant privilege” granted to the U.S. economy. This privilege consists in having amacroeconomic autonomy unparalleled in the other economies; i.e. it doesn’t face true externalconstraint and enjoys easier financing conditions, since it is able to run indebted at a lower cost, withneither exchange risks nor increasing spreads with the size of its debt, because it pays foreigners byissuing its own currency or paying with its Treasury Bonds. This peculiar asymmetry biases themacroeconomic conditions as it freezes the global re-balancing mechanism. This bias consists infacilitating foreign financing of fiscal and balance of payment imbalances, which in turn discouragesboth public and private savings. Thus, global macroeconomic imbalances tend to perpetuate, creatingthe risk of global inflation due to a lack of an effective nominal anchor. (See Box No. 2). Triffin dilemmacharacterizes, although with different modalities, both the extinct fixed exchange-rate system of BrettonWoods, as well as the anti-saving bias in the present floating system. Both systems are based on thedemand for reserves by the Central Banks of the world, from public liabilities of the U.S., which leads totoo low US interest rates and an excessive indebtedness of this economy. At some day this will destroy thetrust in the dollar, which precisely lies on its condition as international currency. In any event, in such asystem, the creation of international liquidity cannot be optimal, but rather due in the best cases totemporary chance.

7 ) The Triffin's dilemma explains the " built-in destabiliser " of the US $ regime for the global economy

The present world financial and economic crisis is one of the expressions ofthe systemic defects and inconsistencies of the world economy, based on anasymmetric monetary system which lacks an objective monetary anchor and socreates big monetary waves feeding growing imbalances.

More than half a century ago, the Belgian economist Robert Triffin – one ofthe fathers of European Integration, and of the Euro6 – was the first (andalmost the only one, for many years) to identify in explicit terms, a majorcharacteristic of the post-war international monetary system: the intrinsicinstability produced by the use of a national currency – the U.S. dollar – asthe main international monetary standard, and the resulting asymmetry for the

6 Robert Triffin, (1911-1993), professor at Yale University and at Louvain CatholicUniversity, was both Belgian and American, he was a member of the economic team ofJohn F. Kennedy (who called him the "first transatlantic citizen"), and later becameadviser to the President of the European Commission Sir Roy Jenkins (1977-1981). Inthis position, he inspired the creation of the European Monetary System, which set thebasis of the present Economic and Monetary Union of the EU (Maastricht Treaty, 1992).

14

world economy, with the risk of creating an inadequate degree of globalmonetary liquidity. We must remember his arguments, given the present crisisand the phenomena that have occurred since the collapse of the Bretton Woodssystem in 1971/73, which he had clearly announced in tempore non suspecto (alreadyin the fifties) and was consecrated in the so called "Triffin dilemma" (BOX 1).

This dilemma is still alive because it is broader than the only defects of thedisappeared Bretton Woods peg regime. Indeed, the Triffin's dilemma hassurvived the Bretton Woods regime and remains fully valid for analyzing thepresent IMS failures, as Robert Triffin himself claimed in his post-BrettonWoods publications, denouncing "the logical absurdity and disastrous results of the use of a fewnational currencies as the major, or sole, instrument of international monetary reserves". In thefloating-rate regime succeeding to Bretton Woods, Triffin announced twentyyears ago in crystal clear terms the present "scandal" of the IMS:

"The first shortcoming…is the basic asymmetry it creates…[since] the deficits of a reserve-centre countrymay be financed mostly – or even overfinanced – by an increase of world foreign exchange reserves…[with] no imperative pressure for the readjustment of inflationary policies

The second shortcoming is that this process may easily degenerate into a self-feeding spiral ofinflationary reserve increases, since these are reinvested in the reserve centres and increase the ability oftheir leaders to pursue inflationary policies for any purposes they may wish…

The third shortcoming is the stimulation of lending by poorer and less adequately capitalized countries toricher countries far less dependent on foreign capital for their economic development.

The initial version of the Triffin's dilemma (from the 1950s and 1960s) has tobe viewed as a mere application to the Bretton Woods peg of the globalasymmetry produced by the use of a national currency as the main reservecurrency. Indeed, the outside demand for the US$ as international currency(for trade transactions as for precautionary and financial needs) means thatreserve holders are extending automatic "unrequited" loans to the US economy,whatever the exchange-rate regime is. This confers to the US economy the"exorbitant privilege" (as coined by General De Gaulle and Giscard d'Estaing in1965) not to be submitted to the same external financial constraint as are the"n-1" other economies. Indeed the "nth" currency is held abroad as reserve bythe "n-1" other central banks, whatever a parity-grid exists or not. In anyexchange-rate regimes (except for the textbook-case of pure floating, but inthe real world central banks tend to accumulate a foreign "national' currencyas reserves in counterpart for their monetary base issuance) this is much morethan a privilege, it is also a major monetary spillover abroad since the other"n-1" central banks use the US$ to create a domestic liquidity expansion

15

(except for some fractional degree of sterilization7) by investing their $assets into US liquid financial paper (US T-bills and US Bank CD). This meansthat the liquidity expansion abroad (in "n-1" monetary bases) is not made upfor a parallel contraction in the US monetary base since the excess of US$issued by the FED are not brought back to this nth central bank as deposits ofthe ‘n-1” other Central banks on their accounts to the FED (so on theliability side of the FED balance-sheet) but are re-injected as capitalinflows to the US economy. It is thus clear that the asymmetry of the US$-regime is also the source of global monetary waves i.e. the contrary of arational and stable system of creation of international liquidity.Furthermore, in combination with this policy spillover, the exorbitantprivilege of the $ regime tends to act as a saving-disincentive in the USeconomy, creating or worsening global macroeconomic imbalances.

Therefore the Triffin's dilemma should rather be renamed the Triffin'sasymmetry in order to encompass the more general macroeconomic "built-indestabilizer" identified first by Robert Triffin in the 1950s.

The asymmetry - or the destabilizing spillover from the US$ regime (whateverthe degree of floating of exchange rates) - acts trough two intertwinedmechanical channels:

1. Global imbalances do result automatically from the monetary asymmetrythrough the relief of the external constraint for the US economy, whichpushes down the saving rate (automatic external financing at lowerinterest rate and overvaluation of the $) transforming the US in the"consumer and borrower of last resort" (see details below on page 8), impedingthus the IMS to fulfil its second main role to reduce imbalances and tosmooth adjustments

2. Global monetary waves do result automatically from the asymmetric biasintroduced in monetary policies by the international status of the $;this bias acts as a multiplier abroad of the US monetary and fiscalpolicy stances, impeding thus the IMS to fulfil its main role to issuean adequate degree of global liquidity.

Drawing upon Triffin's three shortcomings cited above, our thesis is thatthese two channels are inter-related, forming a mutually supportive process of

7 Sterilization occurs when the central bank impedes the effects of its exchange-rate interventions to affect the monetary base by selling domestic assets for an amount corresponding to the increase in its $ reserves. However,sterilization is generally very costly for a non-key currency (interest rate differentials with the US $) and are not significant in the longer-run.

16

systemic imbalances creating additional excess of international liquiditywhich in turn worsens the imbalances in a destabilizing and costly cycle. Thiscumulative process is the “built-in de-stabilizer” of the global economyidentified by Triffin as the result from the contradiction of using a nationalcurrency as the international one. As explained in the next section, the USofficial version (Greenspan/Bernanke) of a "World Saving Glut" provoked by anexogenous shift in the savings supply of some emerging economies represents atypical myopic analysis which denies to take on board the spillovers createdby the international status of the $ and makes the US economy a passive actorpowerless in front of some emerging economies. The 2 channels explain thatneither the Chinese saving surpluses nor the US dissaving can be exogenous butare closely linked to the international role of the $.

The first channel (lack of external constraint) explains that the asymmetricrole given to the US $ tends to exacerbate macroeconomic imbalances and USindebtedness, the second one (multiplier effect on global monetary policy)explains the strong spillover issued by the US monetary policy upon globalliquidity conditions, and the combination of both explains the crazy run ofthe world economy towards a process of crisis amplification and loss of globalwelfare.

Indeed, the cumulative circular causation process is the following:

At the beginning, the US $ international role implies growing US liquidindebtedness as the counterpart of the accumulation of reserves in $assets abroad, but the US is not necessarily a net debtor as far as UScapital outflow makes the counterpart of the $ liquid liabilities(banker's role of the US).

But the US $ asymmetric role implies also escaping from the externalconstraint, which means a bias towards “easy money” => cheaper interestrates => fiscal deficits easier to finance => eventually growing excessof absorption over production i.e. growing macroeconomic imbalanceswhich means the US economy becoming increasingly a net debtor (channel1).

Facing such a disequilibrium which drags down activities and jobs in theUS, the FED tries to keep interest rates as low as possible, stimulatingeven more the US over-consumption and the imbalances

But the monetary spillover (channel 2) amplifies abroad the US monetaryexpansion as Foreign central banks needs reserves and/or resist dollardepreciation, and re-inject the excess of US $ in US liquid assets,lowering further the US yields

Therefore, the channel 2 amplifies also the effects of channel 1, bycreating a vicious circle by which the financing of the growing globalimbalances is made possible;

17

This frightening vicious circle of imbalances tends to persist as it isin mutual interests of both the US debtor and its creditors from someemerging economies; the US domestic objectives calls for more externalfinancing that the FED is able to feed through the spillover of its ownstances which allows for more net imports and therefore moreaccumulation of reserves by its creditors.

Although irrational and destabilizing from a systemic point of view, it isfair to acknowledge that these two channels have also fuelled the globaleconomy and contributed to spread economic development, first in Europe andJapan in the 50s and 60s, and later to the benefit of an expanding number ofsuccessfully emerging economies, in particular for getting out of the Asiancrisis of the end of the 90s. Indeed, the US $ regime "solved" transitorilysome deep conflicting issues, although at the costs of instability andworsening crisis with growing financial risks. For example, while it is truethat the Asian crisis was partially solved by the asymmetric process describedabove, it should be taken on board that this crisis was probably the result ofthe FED policy and the asymmetric process itself as well. This answer or"solution” to the Asian crisis led to the next global crisis of 2007/2009, inthe same way as the US answer to the second-oil shock crisis (1979-82) led tothe 1987 stock exchange bubble and the Japan stagnation. According to the sameargument, the US solution” to the present global crisis is probably feedingfurther disequilibrium leading to the following one for 2017.

In spite of the impossibility to draw an exact balance between the benefitsand costs of the dollar regime, it is clear that it has not led to a stableworld and there is no argument for accepting a dysfunctional SMI whichmismanages world liquidity and provokes cumulative monetary policy mistakes.Since economics is supposed to promote rational policies, there is no excusefor postponing actions that could improve a system which feeds instability andremains dangerously dysfunctional with respect to its official purposes.

Going back to channel 1, it is interesting to identify the complex combinationof biases which characterizes the asymmetric nature of the $ regime given byits international monetary role:

1. An asymmetry in the degree of external constraint, the US economy beingexempted of it as far as US $ assets are demanded abroad for reservepurpose, allowing it for sustaining permanent increase in the USexternal debt;

2. A subsequent asymmetry in the macroeconomic policy stances allowing theUS to be the only economy able to embark on expansionist policies

18

without suffering balance-of-payments crises; this gives to the USeconomy the peculiar capacity to absorb durably both excesses of outputand savings coming from the n-1 economies, making the US the“consumer/borrower-of-last-resort”

3. An asymmetry in the costs of financing both US current account deficitsand US fiscal debts (automatic capital inflows due to the demand forreserves in US$ lower the interest rate on the US markets); so the US isable to finance its public debt at a lower cost than if the $ would notbe the key-reserve currency

4. An asymmetry in the exchange-rate risks since the US is able to invoicemore than others in its own currency as well as to borrow from abroad byissuing liabilities in its own currency, shifting entirely the risk uponthe lenders

5. An asymmetry in yields and valuation effects which reflects one aspectof the exorbitant privilege: the excess return on US assets over USliabilities implies an enormous transfer of resources which allows forstabilizing its net international liability position (lowering theincrease in the US external debt with respect to the cumulative currentaccount deficits) and therefore prolonging even more the disequilibrium;US assets invested abroad have higher returns than US Foreignliabilities; this is due to the asymmetry in the composition of the USinternational portfolio (mismatch in the composition of assets withrespect to liabilities) which results also from the internationalmonetary role of the US$: foreign holders of US $ assets are generallylooking for liquid assets and collateral well accepted by internationallenders but with low yield while US holders of Foreign assets aregetting much higher yields. Furthermore, the U.S. reaps a capital gainwhen the dollar depreciates, since U.S. assets abroad are foreigncurrency denominated (the declining trend in the external value of theUS $ is automatically increasing the returns on the US assets abroadwith respect to Foreign assets held in US $).

These combined asymmetries result from the international role of the US $ andrepresent indeed an "exorbitant privilege" which implies significant transfer ofreal resources from the n-1 economies at the benefit of the US. According tomere book-keeping calculations, these net transfers amount to around US $ 1thousand billions from 2001 to 2007 (Alessandrini & Fratianni8). Richard

8Alessandrini, Pietro and Fratianni, Michele, Resurrecting Keynes to Sstabilize the International Monetary System, Money & Finance Research Group, working paper n°1,

19

Clarida9 also shows that between 2002 and 2007, the US net internationalliability position was almost unchanged even though the US ran cumulativecurrent account deficits for $ 3.3 trillion in those five years. Gourinchasand Rey10 explained the mechanism of leveraged financial intermediary which ispermits by the international role of the $.

Despite moving away from fixed parities between the main internationalcurrencies, and a general evolution towards more flexible exchange rates, theasymmetry of the dollar, and its ensuing privilege (resource transfer byissuing liquid liabilities) persisted, despite the development of substitutionbetween financial assets in dollars, and other secondary internationalcurrencies (the other four compounding the SDR at that time plus the SwissFranc). Two reasons can explained the resiliency of the dollar dominance:first, none of these secondary currencies was capable of offering a completealternative to the $ (none got the same degree of characteristics in theirfinancial markets as those prevailing in the US ones in terms of “breadth,deepness and resiliency”); second, world macroeconomic instability thatresulted from the raising substitution between international financial assets(non-monetary assets) provoked an additional demand for dollars in monetaryreserves for increasing the intervention rooms for manoeuvre. Decisiveeconomies of scale together with the network that characterizes theinternational monetary market are technical factors which explains thepersistence of the dollar dominance on the monetary market (very short-termsegments) while their cost-influence diminishes progressively in the longer-term segments of the financial markets.

BOX 2: Monetary asymmetry of the dollar standard in three historic stages

1. Bretton Woods I System (1944-1973)

In that system, fixed parity with the dollar formally forced the n-1 world’s Central Banks to buy excessdollars to respect that parity. However, the world demand for international money made these CentralBanks to save these liquid assets in dollars as external reserves, because at that time, the dollar was theonly complete international currency, i.e., its monetary market offered the necessary technical

Università delle Marche, Ancona, October 20089 Clarida, Richard, "With privilege comes…?", Global Perspective, PIMCO, Sydney, October 200910 Gourinchas, Pierre-Olivier, and Rey, Helène, From World Banker to World Venture Capitalist: US External Adjustment and the Exorbitant Privilege, NBER Working Paper, n°11563, August 2005

20

characteristics (liquidity, depth, and resilience). The fact that these dollars were accumulated on the assetside of the balance-sheet of n-1 Central Banks and paid on the market by issuing their own liabilities,means that these dollars in excess generated also an excess of issued monetary base in the “n-1” othercurrencies. Had there not been an asymmetry caused by the dollar in its role as reserve currency, thatissuance abroad would have been exactly compensated by a contraction in the U.S. monetary base, dueto the fact that these reserve dollars would have been deposited by foreign Central Banks in theirrespective accounts opened at the U.S. Central Bank (The Fed). The reason is that, by definition of themonetary base, dollars that are re-deposited at the Fed – i.e. appears in the liabilities of the Fed withofficial foreign monetary institutions – constitute a destruction of liquidity in dollars. Thus, for anycurrency of the world that is not used as international reserve, in the balance of the Central Bank issuingthat currency, an increase in liability with another Central Bank corresponds to a reduction (in the sameamount) of the monetary base issued by that Central Bank. For example, if the Central Bank of Colombiaacquires Venezuelan bolivars in the foreign currency market, so that the peso does not appreciateagainst the bolivar, these bolivars are re-deposited immediately in the account that the Central Bank ofColombia holds in the Central Bank of Venezuela, thus becoming a monetary liability for Venezuela,which, by definition (whether it is changed for another currency or not) implies an equivalent contractionof the monetary base issued by the Central Bank in Caracas. In this generic case, there is a totalmonetary symmetry: an increase in the monetary base in Colombia is compensated exactly by thecontraction of the Venezuelan monetary base, and these types of interventions of Central Banks tend torestore the balance between the two currencies.

In the case of the dollar, this monetary symmetry could not work, if a national currency is also the maininternational reserve currency, because other Central Banks don’t want to keep it in its monetary form asa simple deposit at the Fed, rather, they want to invest it in profitable financial U.S. assets (as U.S.Treasury Bonds, Certificates of Deposit with commercial Banks in New York) that is, they are immediatelyre-injected in the U.S. economy, preventing the symmetrical reduction of the U.S. monetary base, despitethe fact that it generated an issuance of the counterpart, in the liability of these Central Banks, that is, intheir respective national currencies: the monetary base of the rest of the world increased, but the U.S.monetary base did not decrease. This peculiar asymmetry is explained through the dollar’s function asofficial international reserve standard. This function explains why the dollars acquired in the foreignexchange market by the Central Banks of the rest of the world were kept in the form of profitablefinancial assets – and not in the monetary form in a demand deposit at the Fed – to serve as internationalreserves that could be immediately liquidated in the secondary market of these financial assets in dollars.As the international demand for reserve dollars increases, the U.S. Fed can issue excess dollars – that is,creates liquid debts – that do not return as liquid deposits in the Central Bank, but serve to buy mostlyU.S. Treasury debts. To use a pedagogical analogy, the dollar asymmetry can be seen as the case of areputed consumer, whose checks, issued to pay other agents for his many purchases, are not presentedback to his bank to be collected by his creditors, but rather, they consider more convenient to use them asreserve currency, since they already have a guaranteed liquid market. This implies that this debtor canpay for his purchases only by issuing his own new debts. Then, the condition of international reservegrants it an “exorbitant privilege” (General De Gaulle, 1965) that waives it from the discipline of externalconstraints and financial restrictions.

2. Bretton Woods II System (1973-1999) or the move from floating to managed floating

The move from a fixed exchange system to a floating (or more flexible) system has not translated into areduction of accumulated exchange reserves by the Central Banks of the World. In fact, and contrary to

21

the theoretical models that announced that floating regimes were going to reduce the demand forinternational reserves, what happened was the opposite. The reasons are complex, but rely upon the factthat the floating regime was also asymmetric since the currencies were not on the same foot; the “fear tofloat” by most other currencies maintained the dominant role of the dollar with the consequent spilloversimpeding a symmetrical float. Furthermore, the growing uncertainty over exchange rates developmentincreased the demand for reserves in dollar in parallel to the emergence of massive substitutionsbetween the financial assets in dollar and assets in its partial competitors (the German mark, Japaneseyen, British Pound and French franc). However, these currency substitutions were incomplete due to alack of liquidity and size of the possible alternative to the $ which was explained by the absence of asingle competitor on that time together with the operational need for polarization towards a singlemonetary standard, which favoured the dollar on the monetary markets. In this situation, a new kind ofspillover affected the domestic demand for moneys making them more unstable. Although it is true thatthe link between the U.S. monetary policy and the rest of the world decreased somewhat on the supplyside (segmentation of monetary supplies given the extension of more flexible exchange-rate regimes), itwas replaced by another link (much less visible) on the demand-side. Massive financial substitutions andself-fulfilling speculations increased instabilities in the respective domestic “demands for money”. Thisnew link modified the effective liquidity: when the dollar fell against the D-mark, the internal demand formoney in the U.S. was reduced (thus increasing the effective liquidity of the dollar) while the currenciesagainst which it depreciated, suffered an increase in the internal demand (reducing the liquidity of the D-mark) which was perverse and amplified the currency substitution. This explains the “fear for floating”impeding flotation to be effective (only the U.S. practiced it fully), the Central Banks of the rest of theworld had to increase their interventions and therefore their need for international reserves. As a resultthe U.S. continued to generate “de-stabilizing monetary waves” on the rest of the world.

Thus, the asymmetry of the dollar was maintained. Furthermore, the Bretton Woods II had not even theformal anchor to gold which was supposed to represent a constraint on the US in the Bretton Woods I upto formal Nixon’s decision of 1971 (and de facto up to the end of the Gold pool in 1968). Therefore globalinstability persisted and was even amplified. In early 1985 faced with the challenging urgency to organizean orderly depreciation of the $, the US administration (James Baker) changed its mind abandoning thedoctrine of pure free-floating for a collegial management of exchange rates with target-zones against theother international currencies. This meant the recognition that domestic stability was not anymoresufficient to ensure exchange-rate stability (the official doctrine after Bretton Woods I), and the fact thatboth domestic and external (exchange-rate) stability were officially acknowledged as simultaneouslynecessary and reachable by multilateral surveillance/coordination through a collegial G-5/G-7. Thisgroup piloted the $ adjustment in three steps (1985 Plaza agreement, 1986 Tokyo Summit, 1987 LeLouvre) by setting up a minimum degree of policy coordination in order to share the adjustment burden.Although its collegiality and pragmatism represented already a systemic progress - very useful in crisistime - and although it was successful as regards the objective of managing smoothly the $ depreciationand its successive stabilization, the G-7 failed to reduce the asymmetry and the externalities of the $. Theinner asymmetry due to the US weight was amplified by the intra-European divisions, cleverly exploitedby the Baker administration for forming – especially with the French administration - a “Keynesiancoalition” against the only independent Central Bank of the group at that time - the monetaristBundesbank - for imposing a new loose global monetary stance, through massive interventions of CentralBank self-committed inside the G-7 for stopping the $ fall in 1987. These agreed interventions reproducedagain the Bretton Woods 1 link through money supplies, the monetary stance of the US being imposedand amplified outside, a financial bubble developed in Japan (with fatal consequences for its economy)and a new inflationary wave occurred in 1989-90. The lack of a solution to the Triffin dilemma

22

maintained the systemic instability generating global monetary waves created by the macroeconomicpolicy of the U.S. as a result of the $ asymmetry.

3. The Bretton Woods III system and the emerging economies (1999-2010)

The creation of the Euro in 1999 allowed for the progressive emergence of a second completeinternational currency, with similar technical characteristic as the dollar. However, the fact that there isn’tyet any prospect for single issuer of sovereign bonds for the euro zone, together to the inner forceprevailing on the Forex markets to stick to a single monetary standard for operational reasons, maintainthe predominance of the $ on the interbank markets. Despite a clear progress in the market shares of theeuro in financial markets (it is the first currency for international bonds issue, and the second reservecurrency) in the day-to- day international monetary market 90% of transactions involve the dollar as adirect instrument (dealers need to work with a single operational standard).

The Triffin dilemma (see Box 1), with the same monetary asymmetry and the same macroeconomicprivilege for the US, is then perpetuated with a demand for reserves in dollars, massively invested in U.S.Treasury Bonds. However, in the last ten years that was the case essentially for emerging economies,which took advantage of the U.S. macroeconomic policy, accumulating spectacular amounts of reservesthey invested mainly in $.

This is explained by two main reasons: the growing instability of the world economy (due itself at leastpartially to the $ asymmetry) motivating emerging economies to accumulate excess reserves (counter-cyclical self-insurance motivation due to the lack of collective insurance and to the pro-cyclical pattern ofcapital inflows and trade flows for LDCs), and the efforts of non-renewable resources exporters and ofChina to limit the appreciation of their exchange rates against the $. In the first case, the emergingeconomies try to reinforce their credibility and protect themselves from new external shocks, whether real(terms of trade) or financial (sudden-stop in capital inflows), which are more pro-cyclical and affect themproportionally more than the more advanced economies.

Such a huge demand for reserves in $ fed by the US monetary policy creates feedback effects on this USmonetary policy by contributing to lower US long-term interest rates. This spillover - resulting from the USinternational status – uses to be mis-interpreted by the FED which does not see in it a monetaryconnection between short-term rates to longer ones, but a “saving glut” without relationship with theexcess of liquidity conditions provoked by the FED policy.

The result was a global wave of excessive monetary creation, and its inflationary effects were not evidentin the prices of manufactured goods, except for some commodities and intermediate goods such as steel,due to the spectacular demand from emerging economies (particularly China), but through anunprecedented "credit-boom" which translated into a correlated series of bubbles in the asset prices onreal estate and financial markets worldwide.

The persistent validity of the Triffin dilemma is thus tangible through inappropriate liquidity instabilityworldwide resulting from the de facto international status of the US $.

23

The emergence of the euro in 1999, with an economic and commercial basesimilar to that of the U.S. didn’t change much the strictly monetary role ofthe dollar. Although the € became the second international currency, byquickly offering a monetary and financial market with apparently competitivetechnical characteristics compared with the dollar – thus providing a quasi-alternative to the dollar, and generating an increased substitution infinancial markets – the euro did not replace the dollar in its basic functionas main monetary standard. The reasons are:

1. The fact that the €-area does not provide yet fully unified monetary andfinancial markets as regulations are not yet fully harmonized andoverall there is no genuine lender-of-last-resort in the €-area sincethere is not yet a mechanism for tackling financial crisis and the ECBis prohibited by the Treaty to bail-out or to buy directly sovereignbonds.

2. The $ role is still dominant on the monetary exchange market, since onlyone monetary instrument fits technically as the effective vehicle forintra-day or day to day transactions (dealers cannot work simultaneouslywith 2 competing standards), and the Euro absorbs only secondarycurrency papers: the dollar is still present in more than 90% ofexchange transactions, whereas the € is present in only 40% (and mostlyas a counterpart of the dollar).11

Therefore the asymmetry has persisted. The disappearance and abandonment ofthe Bretton Woods system - the theoretical convertibility of the dollar intogold at a fixed price - accentuated the lack of a nominal anchor for theissuance of currency in the world.

In the last three decades, a succession of at least six international waves ofcrises with increasing amplitude – and with exchange rate instabilities thatinduced wide fluctuations in real exchanges – have shaken the world economy,causing exponential socio-economic damages:

1. The first oil shock and inflationary wave of the first half of the 1970s2. The second oil shock and debt crisis of developing countries in 1979-82

along with the second global inflationary wave3. The financial crisis that affected particularly the stock exchange bubble

in Japan in 19874. The Asian crisis of 1997

11 By definition, the exchange market always involves two currencies, which explainsthe fact that these percentages, 90 and 40, add to more than 100% (part of the 40% isalready included in the 90%).

24

5. The "dot-com" bubble of 2000 6. The 2007-08 global bubble and the great recession of 2009.

Although each of these crises have had their own characteristics, and cangenerally be explained separately, all share the negative effects of the sameasymmetry and lack of objective anchoring that comes from the dollar standardthe world economy relies on.

The U.S. monetary policy, unavoidably and legitimately oriented towards theinternal needs of the U.S. economy according to its institutional mandate, hasgenerated significant external effects on global liquidity, which areincompatible with the preservation of world economic stability.

In turn, the international status of the $ creates specific relationshipsbetween the international demand for $ (as foreign-exchange reserves) and thebehaviour of US interest rates. As far as US monetary policy creates an excessof international liquidity which is in fact re-lent to the US economy bybuying US bonds, US interest rates should be maintained lower than otherwiseas a result of the international status of the $. So world economy developsalso feedback effects on the US monetary policy. Furthermore, as far as theFed believes it has no control upon its long-term interest rates (as didGreenspan’s stance, see below) the reserve demand for US T-bonds creates theillusion that low interest rates on these US long-term bonds reflects a“saving glut” and not an excess of liquidity. This illusion plays anamplification role in the unstable monetary conditions.

Amazingly, these important spillovers are acknowledged neither by academictextbooks nor by most economists (and none textbook) who continue to consider- as most International Financial Institutions - that in a floating-exchange-rate regime, national monetary policies keep their full autonomy, the US onebeing supposed to work on the same foot as the Chilean one!

8 ) The Triffin's asymmetry in the global crisis 2007/2009

In the recent episode of the global bubble, an especially perverse combinationof factors acted in a mutually supportive process: the four-decade expansivemonetary policy of the FED, combined in the last two decades with theexplosive leveraging caused by the simultaneous financial deregulation, themoderating effects on prices and salaries generated by the massive supply ofgoods and services from the emerging economies, the consequent self-confidenceof central bankers making them to believe in their own credibility loweringlong-run interest rates as well as in the financial-market self-regulation.

25

All these interconnected factors acted together for sustaining the growingmacro-financial imbalances, but only postponing unavoidable adjustmentsthrough an unprecedented global "credit-boom", spurring unsustainableconsumption and indebtedness in many countries.

Although these connections deserve serious empirical works, a mere factualobservation allows for establishing clearly the existence of imbalanceddevelopment and recurrent instability. Nevertheless, the Greenspan/Bernanke’sargument for explaining the bubble as a result of an exogenous "world saving glut”(responsible for too low long run interest rates) continues to be invoked asan excuse12 because this would be beyond the control of Fed. However, there isno serious empirical support and the existence and persistence of numerouspolicy distortions in China strengthening high Chinese savings are not enoughfor giving a causation sense to an identity. This very high saving rate in asingle economy does not help to explain too low world interest rates sincethis “excess of savings” mirrors the opposite excess of negative savings inthe US economy. Conversely, Chinese authorities cannot blame the over-consuming americans for their excess of savings. This would be just a"chicken-and-egg" question if the spillovers of the $ are not taken intoaccount. In particular, the 2 channels identified in section 3 above make thelink between the US macroeconomic policy stance and the growing internationalimbalances, namely by feeding with global monetary policy the emergingeconomies purchases of long-term US bonds, explaining so the too low interestrates also at the long-term end of the US market.

In addition to this explanation, it is amazing and irrational to see the USauthorities arguing that their economy is now totally dependent fromparameters fixed by smaller economies.

Furthermore, it sounds strange to speak seriously about a global excess insavings when the world rate of saving and investment is on a persistent

12 See for example http://www.brookings.edu/~/media/Files/Programs/ES/BPEA/2010_spring_bpea_papers/spring2010_greenspan.pdfthe recent Greenspan’s report “The Crisis” second draft March 9 2010, fully supported by a lot of economists like Greg Mankiw http://gregmankiw.blogspot.com/2010/03/comments-on-alan-greenspans-crisis.htmlwho considers that central bankers could not have prevented the bubble or the crisis: “ this is wishful thinking in the extreme. It indeed would be nice if somehow those individuals guiding our national economy had superhuman powers to see into the future (Nouriel Roubini, for example)”. Implicitly this sentence makes this Professor telling that monetary policy would have no impact and so that Central Bankers would be useless for the cycle...

26

downward trend (from 24% of GDP in the 1970s to 22 in the 1980s and less than22% in those early 2000s when the interest rates were so low). It is alsodifficult to believe that global savings would be too high when the crisismade clear the over indebtedness process and the worrying prospects of meetingthe ageing impacts, the environment challenges and the under-developmentconstraints.

Although Central bankers use to believe they can only control short-terminterest rates, it is really difficult to admit that maintaining voluntarilyand persistently negative interest rates (considered however as a typicalgross mistake by the Central banking doctrine) and diverging so strongly fromthe conventional wisdom of the Taylor rule would not be translated into anexcess of liquidity leading to a boom-bust development. As John Taylor’s chartshows13, modelling an alternative monetary stance respecting a Taylor’s rulewould have meant no bubble in the US home market. The first chart shows whatshould have been the interest rates according to the Taylor rule and on thesecond one the “counterfactual” curve indicates the alternative development ofthe housing starts in case US interest rates would have followed the Taylorrule.

13 John Taylor, The Financial Crisis and the Policy Responses: An Empirical Analysis of What Went Wrong” November 2008

27

In industrialized economies, in spite of the easy-money stance of centralbanks14, the production growth was moderate, whereas the emerging economiesaccelerated their growth, accumulating a massive external surplus which theseeconomies transformed into foreign financial assets, mainly in dollars andU.S. Treasury liabilities, that is, in international reserves and not in realassets, maintaining the downward pressure upon long-run rates. Thus, theseeconomies participate directly in the multiplication of liquidity createdoriginally by the U.S., reproducing de facto the greatest defect of the BrettonWoods II system (or even Bretton Woods III, see Box 2) created by aspontaneous demand for reserve in dollars by emerging economies. Thisexcessive demand for reserves is explained in part by strong policydistortions in some emerging economies, especially in China with an under-valuation of exchange rate combined with financial repression and wageincreases lower than productivity increase, compression the consumption sharein the PIB which fell from 52% in the 1980 to only 36% in 2010. In addition,the excess demand for reserve reflects a reaction of precaution from emergingeconomies given their higher exposition to global instability, through eithertheir terms of trade sensitivity to the world cycle or their dependency uponforeign capital movements .

The recent global bubble of the last few years illustrates clearly that theprinciple of a global monetary wave invaded the world. Not even the euro andits independent European Central Bank, which is immune against politicalinterferences, was able to escape to this wave, its resistance attemptsresulting in an overvaluation of the euro against the dollar. This risk

14 As indicated by a Taylor rule, the interest rates in the US and the euro area were significantly well below what historical experience would suggest policy should be. See John Taylor, The Financial Crisis and the Policy Responses: An Empirical Analysis of What Went Wrong” November 2008

28

clearly shows the lack of a nominal anchor worldwide: if the FED issues toomany dollars, the drop in its exchange rate with respect to the euro becomesexcessive, tends to give the impression of a restrictive monetary stance fromthe European Central Bank (ECB) with respect to its internal inflation goals(in terms of real goods and services). This implicit pressure forces the ECBto partially follow the FED in its monetary laxity, which reinforces foreignsurpluses in emerging markets and their demand for reserves, thus worseningthe global monetary wave produced by the dollar regime. Therefore, it is naiveto believe that a nominal anchor could exist only through “inflation targeting” bythe FED and the ECB, unless this inflation is measured beforehand, includingfinancial assets and using a (not-yet-existing) model that perfectly reflectsthe world economy. As shown also by John Taylor15, the ECB did not respecteither the elementary Taylor rule and this gap (the blue line on the chartbelow) would be mainly explained by the Fed influence (the red line) upon ECBmonetary policy.

The dominating macroeconomic policy schemes (like those represented in thecurrently used models – the “Dynamic Stochastic General Equilibrium Models”) are basedon the double paradigm of symmetric economies (the illusion that the worldeconomy is just the addition of similar economies) combined with the presenceof efficient markets, rational anticipation, and self-stabilized financialmarkets. These models, used by all policy makers, proved incapable ofexplaining the “global credit-boom” and its bubble effect in macroeconomicschemes. Specifically, this ruling double paradigm explains the belief that

15 John Taylor, The Financial Crisis and the Policy Responses: An Empirical Analysis of What Went Wrong” November 2008

29

world macroeconomic stability could result from a successful “inflation targeting”by all national monetary policies simultaneously.

The greatest error lies in the inadequate incorporation of spillovers from thedollar standard, which creates wide monetary waves as a consequence of theTriffin dilemma, and an inadequate management of international liquiditycreation, in an IMS based on a national currency. Specifically, a lack ofanchor in the present IMS leads inevitably to conflicting national policies,producing costly uncertainties for future exchange rates development betweenthe main currencies, and therefore threatening eventually the access toforeign markets. The present “non-monetary system” unable to regulateinternational reserves creation and global liquidity is a threat to the well-being of the world.

BOX 3: The illusion and failure of the free floating-rates as a stable global regime

The theoretical prediction that free-floating would allow to insulate economies from external monetarywaves as the exchange rate adjustments would internalize the spillovers from outside monetary policiesproves to be an intellectual failure. Indeed, textbooks argument that floating would cut dramatically theneed for reserves illustrates this failure. The argument was that eradicating the exchange-rate fixitywould cut also the link between monetary bases across frontiers, allowing for full monetary policyautonomy and protecting from outside monetary impacts. In the real world, the need for a common operational tool for conducting intraday internationaltransactions creates centripetal forces for using a main one or even a single one. This generatesimportant spillovers across the economies. For small-and-medium economies, there is a clear argumentfor not abandoning passively their crucial exchange-rate determination to free markets exposed to wildglobalized capital flows (fear of floating). But also for more important currencies a key-spillover is theimpact of currency substitutions upon the respective domestic demands for moneys which complicatesthe Central banker mission (Mackinnon argument developed before the existence of the €). Thesespillovers explain the absence of a genuine free-floating since most economies maintained someexchange-rate objectives while the US almost did not intervene on the exchange-market. Even in theabsence of direct interventions of Central Banks (on the exchange market) some implicit exchange-ratetargets could be followed through indirect interventions i.e. by adjusting interest rates/ monetary basewithout any need to change reserve assets. So a hidden “Bretton Woods” with some monetarytransmission from the Fed still does exist under apparent floating regime!

With the emergence of the € in 1999, the situation was almost unchanged in spite of an apparentgenuine free-float across the Atlantic, maintaining a current account equilibrium for the € area. Theinternational role of the $ was only marginally reduced.

Furthermore for emerging economies, the global instability condemns them to pro-cyclical policies andexchange-rate shocks (through capital inflows, terms of trade effects and trade volumes) which amplifythe macro-instability. Drawing lessons from the Asian crisis of 1997 they are tempted to oppose to free-floating for preventing domestic financial crashes, and for not becoming dependent from the IMF and

30

international financial markets. Therefore, they focus their strategy upon an export-led growth foraccumulating $ reserves with their saving surpluses. Such a self-insurance option by pilling-up hugereserves (more than 25% of their GDP !) implies enormous exchange-rate interventions, strong capitalcontrols and policy distortions with high social costs. This very inefficient solution for making-up forglobal instability is due to the lack of trust into a collective-insurance mechanisms (with IMF intervention),but expressed also the failure of floating-regime to become a global one able to solve the asymmetry byinternalizing – as in the textbook case – the spillovers from the $ regime. Since externalities cannot besolved by definition by free markets, there is a case for collective intervention i.e. the IMS and the globalstability are intertwined public goods,

9. What are the main axes for building a global solution to the IMS issue?

The previous sections have set and explained in details the reasons and thekey aspects necessary for identifying the components of a coherent IMS.Building such a functional system means merely to solve the Triffin dilemma.Essentially this is a global governance issue for finding the best practicableway for escaping the redundancy issue inherent to monetary interdependenciesby allowing for a more rational management of the international liquidityconditions. As analysed above, correcting the contradiction of the presentdollar-system should contributes significantly to the global rebalancing whichis necessary for ensuring a more stable world economy.

For the sake of clarity, let’s refer first to the core-principles withoutconsidering first the practicalities or the political aspects. So it should beeasier to deal with the operational aspects once the final target and itspotential merits and benefits are clearly perceived.

In theory, the solution for improving the stability of global monetaryconditions is indeed very simple and eliminates by definition a high number ofexisting ideas and debates for correcting the present system. It could besynthetized in a single sentence:

Eradicating the Triffin dilemma would solve the built-in destabilizer inherent to the present dollarsystem as far as a this main key-currency (as well as the others) could be substituted by a (new)multilateral currency the issuance of which could be managed by the IMF for anchoring its valueby preventing deflationary or inflationary waves.

This solution should be articulated according to the following blocks ofprinciples:

1) As any currency, the adequate international reserve currency must be aperfectly liquid and reliable debt, therefore the only international

31

liability able to maintain this credible quality cannot be the debt of apeculiar economy but a liability of the IMF, which would be issued asthe counterpart of new assets bought by this IMF through such anymonetary creation. The inner logic is exactly the same which led to thenational currencies issued by national Central Bank issuing moneywithout creating direct net debt. So the IMF could become a genuineMultilateral Central Bank (MCB-IMF);

2) The issuing entity – the MCB-IMF (as it already exists but better ifrebalanced in favour of emerging economies) – is mandated for buying(under strict limits), predefined eligible assets from its member statesheld by the national Central Banks and pays them by creating (new)Multilateral Drawing Rights (MDR), crediting them at the nationalCentral Bank account to the MCB; these new SDR (or MDR) are the samekind of basket currency compounded from main key-currencies (also betterif previously rebalanced for being representative of the polarisedfinancial world); the MDR are a closed basket i.e. there are a fixednumber of national currency units so the weight of each currencyfluctuate according the exchange-rate changes.

3) The first step for issuing MDR is made through a massive swap (forexample 30% of the assets) between each national Central Bank and theMCB/IMF but without any additional liquidity creation (contrary to ageneral allocation of DTS). In this first step, the purpose is toincrease the balance-sheet of the MCB-IMF (and therefore the share ofthe new multilateral currency). Only national Central Banks domesticassets yielding interest rates are swapped against MDR; as each centralbank receives the counter value in MDR at the current exchange rates,debits and credits cancel out permanently, there is no open position inthe MCB therefore it bears no inflationary risks and no exchange-raterisks; as the issuance of MDR is made against domestic assets held bythe national central banks, the received amount of MDR substitutes forthe value of these assets in the monetary base in each economy so thatthere is no monetary creation: the global monetary base is not affectedby these swap between national central banks and the MCB and thecorresponding shift in the composition of the asset side of each CentralBank. This is a difference with respect to the Keynes and Triffin planswhich were exclusively based upon a transfer of reserves from nationalCentral Bank to the IMF. The reason is double: (i) to focus better uponthe pure monetary base creation while (ii) preventing the nationalistic(erroneous) reflex from non-economists (and populists) about “losingnational patrimonial wealth to international bureaucracy”. It is much

32

more meaningful (and politically easier) to swap domestic paper indomestic currency against pure global reserves in multilateral currency.There is no need to swap only assets covering existing nationalreserves.

4) In addition to this neutral increase in the share of MDR in the reserve,a second step for creating or destroying additional liquidity could beeasily organized. This crucial step consist in allowing for the MCB-IMFto issue a limited net amount of monetary base for easing the adjustmentof imbalances according to objective rules under collegial monitoring.MCB-IMF opens to deficit economies a credit line in MDR (increasing theasset side of MBC balance-sheet) proportional to the total deposit ofthe deficit economies (i.e. to their economic and financial weight), anddepositing them in their corresponding account at the MDR (increasingthe liability side i.e. increasing the world monetary base). This puremonetary creation operates as it uses to do in any national centralbank. The room for this creation of world monetary base is voted by theboard of the MBC in function of objective rules for smoothing externaladjustments while taking into account the balance of inflation risks: incase of clear negative output gap (unemployment risk) the burden ofadjustment falls on surplus countries, in case of clear positive outputgap (inflation risks) the deficit economies have to adjust first, withintermediate, graduated options for case in-between. This pure monetarycreation introduces the ability to control global liquidity and toprevent the contractionary bias by providing conditional liquidity todeficit economies, the most important property which transforms thepresent IMF into a genuine MBC. It ensures an external adjustmentwithout contractionary bias by fixing the burden-sharing between deficitand surplus countries in a symmetric way. This limited credit facilityfor deficit countries is an old Keynes/Triffin's' idea for reproducingat world level exactly what was historically done at each national levelby creating national central banks as a lender of last resort entrustedto issue a national “symmetric liability” used by any national depositbank for clearing its final payments to the others and acceding to anoverdraft facility.

5) This mechanism of issuance at the global level allows for creating aradical symmetry since the international money is a liability issued bythe global system and not anymore the liquid debt of a dominant economy.As far as the MDR becomes the main settlement tools, all theparticipants face the same need to acquire international reserves asclaims upon the system and not anymore upon a single economy. Although

33

such a reform seems à-priori radical, it must be observed that it is infact more realistic than to preach for implementing global governanceable to coordinate from the centre "n" sovereign policies and to enforcedecisions to sovereign states and Parliaments. Indeed, it is clear thatcreating a multilateral reserve currency does not need neitherinstitutional loss of sovereignty nor significant institutional changessince it is essentially based upon an automatic mechanism which isfurthermore manageable collegially for making it acceptableprogressively by all participants. So, this option of a multilateralreserve currency is effectively the most “subsidiarity conform”solution.

6) However, there is still a need to agree upon two basic complements forwhich an international additional bargaining is inevitable. It wouldlead to a new international monetary convention: first, the members ofthe agreement commit to give preference to use MDR for making finalsettlements between central banks. Although this commitment imposes asymmetric constraint, it also gives access to the overdraft facilitywhich opens an attractive global room for manoeuvre with the netissuance of MDR through the multilaterally regulated overdraft facility(credit lines by steps according to objective quotas). Such a preferenceshould imply giving to the MDR a market interest rate together with thefaculty to substitute MDR for any foreign assets held by a central bank.Second, it is also necessary for ensuring a full symmetry to rule outthe possibility of sterilization of interventions (as in Keynes' Plan).In this case, when China – for example - wants to substitute MDR for $held in US T-Bills, the Central Bank of China sells these US T-Bills onthe interbank market, shifts the product of this sale from its USbanking correspondent to its account at the FED (= a decrease in the USmonetary base and an increase in the Chinese monetary base), thenexchanges these $ liquid assets for liquid MDR at the MCB. The neededMDR are debited on the FED account with the MCB (which could borrow themin the limit of its credit line) and credited on the Chinese accountwith the MCB. The global monetary base remains unchanged and theadjustment is perfectly symmetric with a burden-sharing across botheconomies, and the same exchange-rate risks for both the debtor and thecreditor (the US increases its debt in more stable MDR and Chinaincreases its assets in these stable MDR).

34

Simplified scheme of the Balance-sheet of the Multilateral Central Bank

ASSETSA1 + A2 =total assets of the MCB-IMF upon "n" countries:

A1. National Bonds (n countries) in “n” different currencies (valued at market against the MDR at each swap)

+A2. Credit lines in MDR to National Central Banks (deficit countries) (activated according to world cycle position under qualified majority vote at MCB)

LIABILITIES= World Monetary Base = P1+P2= total liquid liabilities

P1. Deposits of "n" national Central Banks in DTM at MCB-IMF (counterpart of the « n » nationalbonds swapped to the MCB (same value as on the asset side, no exchange-rate risk for MCB+

P2. Reserve Deposits in MDR from national Central Banks(counterpart of MCB-IMF overdraftsgiven to national CB

Along these guidelines, the IMS could be radically stabilized into a win-wingame. These guidelines mean that international currency could not be any morea commodity like gold, nor a national currency, neither a group of competingkey-currencies in order to be “above any national currency” allowing for a global(multilateral) lender of last resort issuing its own liabilities as the onlysymmetrical (“outside” or “n+1” or supranational) tool for internationalpayments between central banks. This multilateral currency (our MDR) wouldsubstitute the existing Special Drawing Right and provide the tool the worldeconomy very much needs for solving not only the present $ asymmetry but alsothe burden sharing between deficit and surplus economies in order to preventthe risk of external adjustment being realized at the expense of internalequilibrium i.e. without higher under-employment and without deep recession.

Indeed, a liquid asset held upon this multilateral institution is symmetricalin terms of exchange-rate risks and impact upon external financing of the “n”different economies of the world. Any economy must buy it and needs to acquirethe other currency components for getting it, thus introducing an externalconstraint for all with an exchange-rate risk for any debtor. But it is not

35

sufficient to eradicate the inner $ asymmetry because this $ asymmetry -although presently unstable, costly and unfair – uses to solve in fact (notefficiently and not fairly) another global risk of opposite asymmetry whichcould be even worse that the costs of the present $ standard: if the US wouldbecome immediately a “normal” deficit economy (exposed to exchange-rate riskand financial external constraint as the n-1 others) a big deflationary biaswould substitute the present inflationary risk since the FED would not be anymore able to feed the US role of “world-consumer-of-last-resort” which hasbeen using to play for being the motor of the world demand since World-War-II.There is a clear case for a burden sharing between surplus and deficitcountries.

As Keynes explained clearly 70 years ago in the first version of its reformplan in September 1941, the international financial system contained acontractionary bias in the way it imposed most of the burden of balance-ofpayments adjustment on the deficit countries, rather than the surpluscountries. The external constraint is inherently asymmetric and deflationaryas it tends to depress world demand because the constraint upon deficitcountries to balance their account is stronger that the disposition of surpluseconomy to adjust by saving less:

“It is characteristic of a freely convertible international standard that it throws the main burdenof adjustment on the country which is in the debtor position on the international balance of payments –that is, on the country which is (in this context) by hypothesis the weaker and above all the smaller incomparison with the other side of the scale which (for this purpose) is the rest of the world.”16

Therefore any spontaneous equilibrium (whatever the exchange-rate regime wouldbe fixed or flexible) would result in a sub-optimal level for global demandand activity. Inevitably, reserve accumulation plays a negative impact onglobal aggregate demand as far as a global lender-of-last-resort is notestablished. The imperfect solution provided by the $ standard leading to makethe US the “deficit-economy-of-last-resort” through too expansionist fiscaland monetary policies led to an inacceptable global instability. The logicalsimplest solution is to introduce in the IMS a specific mechanism that wouldlimit and prevent (or compensate) excess hoarding of liquid assets (foreignexchange reserves) by the surplus countries, and which would instead encouragethose countries to “spend any excessive trade surplus earnings by buying producible from deficitnations, thereby permitting the deficit nations to work their way out of debt”17

16 Keynes, John Maynard, Post-War Currency Policy (1941) reprinted in The Collected Writings of John Maynard Keynes, vol 25, ed. D. Moggridge (Macmillan, London, 1980, p. 27)17 Davidson, Paul, The Keynes Solution, Palgrave-Macmillan, New York, 2009

36

These possible mechanisms are only two: either the national authorities acceptto coordinate strictly their policy mixes for obliging surplus economies tospend (what we know to be totally unrealistic or anti-democratic) or theypreserve their respective legitimate sovereignty by accepting to decidetogether a multilateral rule-based-world-monetary regime. Such an agreementwould decide in advance a burden-sharing system with incentives for preventingany bias combined with a transparent issuance rule for the "MultilateralDrawing Rights". To move to such a Keynes/Triffin's rational monetary order requires threeinnovations with respect to the present IMS:

first to impose merely the MDR as the only universal liquidity forinternational payments across central banks; this implies to upgrade thepresent SDR in a genuine currency, to transform the present IMF into arepresentative Multilateral Central Bank with deposit accounts from then central banks, managing a substitution account for converting excess $balance in an orderly way and organizing conditional loans with thedeposits from the surplus countries for providing liquidity to thedeficit ones along some common guidelines (conditionality).

Second, the net issuance of MDR is decided on technical criteria by thisnew Independent Multilateral Central Bank, controlled by a board ofrepresentatives of central bankers according to objective criteria(reflecting the recent changes in world economy) and reportingpermanently to the IMF Board, and annually to the IMF general assembly.

Third, an adjustment incentive mechanism for making symmetrical therebalancing efforts and enacting some basic objective rules forpreventing continual over saving by surplus nations and disciplining theeconomies running excessive deficits and debts, surplus economies wouldget incentives for making up for macroeconomic effects of deficit-reduction measures in order to minimize the global activity costs of anytrade adjustment.

In practical terms the difficulty for implementing these first best principlesin the present world concentrates upon two questions: first how to organizethe changeover from the existing $ standard to a new multilateral standard,second how to agree upon the governance scheme and rules in charge of managingthis n+1 currency.

Is really true that “the devil would remain in the details” and that such a plan wouldlook utopian? Not necessarily as the institutional aspects mainly alreadyexist and the presently growing risks for all the participants should makethem more incline to cooperate in their own interests.

37

Indeed, all the necessary components are already at hands but just needs to beactivated in the right direction, what should result from the common fearsrising with the already-coming next phase of the global crisis:

The institutional basis of such a potential and ideal new standardalready exists in the present IMF status with its account-currency - theforty-five-years-old “Special Drawing Right”, alias SDR, and theinstitutional decision-making mechanism provided by the IMF itself whichare sufficient for transforming the existing SDR into the MDR.

Furthermore the Article VIII of IMF status sets explicitly the objectiveof making the SDR the principle reserve asset in the IMS, giving thefull legitimacy to upgrading the SDR into the MDR and making the IMFmore representative, technical and endowed with adequate tools

The precedent of the move from the ECU basket to a fully-fledgedcurrency shows that upgrading the SDR into a genuine currency - the MDR- issued by a new Central Bank of central banks is not a technicalproblem. The same European experience with the private use of the ECUbasket shows how to easily extend the market operations in asupranational basket currency

The emerging economies supported by the other LDCs are pressing theadvanced ones for rebalancing the IMF offering them an opportune win-windeal for getting a global consensus which would allow for a safer andmore rational IMS: more rebalancing efforts from the surplus countriesin exchange for more weight to them in the IMF and more transparentrules in the issuance of the world liquidity

10. What are the operational steps able to open the way to a global IMS Reform?

It is clear that political authorities bear the full responsibility of therisky status quo and it is a shame that the crisis has not yet led to moreconcrete steps towards a global reform. In order to bring concrete positiveideas rather than blaming others, the following proposals are made.

There are two concrete experiments which could open interesting path able toease the move towards a more stable IMS or even to create a favourablemomentum.

The first one consists – in the absence of a straight change in the SDR/IMFrules for creating a genuine currency - in developing the use of the existingSDR both for public and private sectors along the same kind of lines as thoseimplemented in the framework of the European Monetary System, when the ECU

38

basket was adopted by the private sectors for issuing debts and making privatepayments in addition to its official role in the ERM. This “parallel currency”option could – along the same lines as the Triffin's proposal endorsed by theEuropean League for Economic Cooperation in May 1978 - allow for creating themomentum showing the interests and effective demand for such a compositemonetary unit which offers more stability due to the automatic diversificationaway from national currencies. This would be attractive both for issuingdebts, holding reserves, billing trade flows, or managing exchange-ratepolicies. Significant changes are required however as to pay an attractiveinterest rate on asset in SDR.

In parallel, official negotiations must be opened between those countries orGroups dealing with IMS issues, and this could open the complementary pathleading to the global reform.

The second experiment – also very Triffinian - consists indeed in acting inparallel for strengthening monetary cooperation across emerging and LDCseconomies regrouped by geographical regions., This supporting option exploitsthe “regional integration” cohesion force or argument for building regionalconsensus and tools, making easier a participation of LDCs in the globalreform or giving them more weight. For example, by creating themselves analternative option of “regional insurance” by pooling their reserves, theycould move alone on their own initiative and speed, creating so a positivebreak in the present status quo they cannot change by themselves otherwise.There is an urgent need to rebalance the voices and powers in thosemultilateral institutions in charge of systemic global issues, increasing theparticipation and responsibility of LDCs. The main reason for giving them moreweight is to restore and strengthen the legitimacy and relevance of themultilateral institutions on which global reforms and governance will bebased. Precisely their interests to participate to and benefit from a globalsolution to IMS asymmetries are higher and their potential impacts are alsohigher when the future is taken on board. LDCs are more affected by theasymmetries and the world monetary waves, they suffer more from global crisissince they depend more upon financial markets, have less resilience andresources to cushion the negative spillovers which push them to amplifyinstability by pursuing pro-cyclical policies.

Therefore, a global reform must involve LDCs and seize the opportunity thegrowing weight of some emerging economies is offering for changing the statusquo. If there is no fast agreement in this direction, LDCs could opt forcompeting by creating their own provisional solution i.e. to create a RegionalMonetary System (RMS) either along the lines of the EMS in Europe in the 1970s

39

or adapting this experiment to their own preferences. There exist someproposals, but their discussion opens other aspects which cannot be deal within this paper. See for example SELA18 .

18 See SELA (2009). Latin American and Caribbean experiences with Monetary andFinancial Cooperation. Critical Balance and proposals for actions with a regionalscope (SP/Di No. 10-09). This document is the basis for discussions that took place atthe Regional Meeting “Reform of the International Financial Architecture and Monetaryand Financial Cooperation in Latin America and the Caribbean”, held at SELAheadquarters, Caracas, 8 and 9 April 2010.

40