Hints Of Change In The World Monetary System

The Wall Street Journal (Link) - Michael Casey (September 1, 2010)

Ever since its inception 66 years ago, the International Monetary Fund has fancied itself at the center of the global economy.

But only now does the prospect of a multilateral monetary authority providing stability to the international financial system seem even remotely possible. That�s because for the first time in decades there are legitimate uncertainties surrounding the one institution that does play that role: the U.S. dollar.

In that context, a couple of recent IMF-related announcements are more important than they normally would be.

On Monday, the IMF said it would dramatically increase lending to a wide array of developing countries through a new �precautionary credit line� under which they would pre-qualify for loans to be drawn upon in a crisis.

Then on Tuesday, South Korea, which will host the Group of 20 nations summit in November, said it would no longer keep its proposal for a global system of currency swaps on the agenda of that meeting. Instead, it would seek a new role for the IMF for containing global financial turmoil--in effect, endorsing the IMF�s alternative plan for a �global stabilization mechanism,� which would be available to groups of countries.

Whether there is support from either the developing world or the G-20 for these two ideas remains to be seen. There is still a stigma associated with borrowing from the IMF, as much as the Fund is trying to break it down. And the U.S., the only country with veto power on the IMF board, might resist reforms that could in some way weaken the power-broking influence that the current system affords it whenever crises erupt.

But the balance of power in the global economy is shifting, with Emerging Asia growing at almost double-digit rates while the economies of the U.S. and Europe are mired in post-crisis debt. The fact that these proposals are coming forward is an indication that many nations are wary about depending on the U.S. when its own outlook is so weak.

For now, demand for the dollar as a reserve currency is hardly waning. This year�s record-breaking bull run in U.S. Treasurys is evidence of that.

But China is shifting some of its $2.4 trillion in reserves into Japanese yen and Korean won, which in part explains the recent runup in those currencies. And whereas the Federal Reserve�s currency swap agreements with other central banks played a critical role in boosting global dollar liquidity during the 2008 financial crisis, these have since been complemented by bilateral and multilateral swap agreements in which the U.S. does not figure.

Most important is the Chiang Mai Initiative, launched in March by the 10 members of the Association of Southeast Asian Nations plus China, Japan and South Korea. That program draws upon a pool of $120 billion in foreign reserves to back a multilateral system of currency swaps that can be triggered if a member faces a currency crisis.

South Korea had wanted to use the Chiang Mai Initiative as a template for a global currency swap agreement. But on Tuesday, Seoul�s Presidential Committee for the G-20 Summit said �the majority views (among the G-20) are that such an idea could infringe upon the sovereignty of central banks.�

Presumably, the Fed and the European Central Bank are uncomfortable committing to accept certain currencies of potentially dubious value. Ironically, however, the interest in multilateral solutions is greatly dictated by other countries� concerns about the dollar.

In this sense, an expanded IMF stabilization fund--one that�s not just geared toward developing nations but toward protecting the whole world from financial turmoil--offers a compromise.

Were it to take off, the IMF could evolve into a true international lender of last resort. And giving a multilateral body like the IMF more power at the expense of the U.S. would surely be preferable to having another, potentially less benign superpower simply takeover the reins.

The dollar is still king. But times are changing. It�s in everybody�s interest to design an international framework before the next big crisis erupts.