As a result many of the world's most vibrant economies in effect shadow the dollar, in an arrangement that has been dubbed “Bretton Woods 2”. Many other emerging economies, especially in Asia, are reluctant to risk their competitiveness by letting their currencies rise by much. And because China limits capital flows more extensively and successfully than others, it has been able to keep the yuan cheap without stoking consumer-price inflation.Ĭhina alone explains a large fraction of the global build-up of reserves (see chart 3). The yuan is widely held to be undervalued, though it has risen faster in real than in nominal terms (see article). It is the biggest of them, and its currency is in effect tied to the dollar. ![]() ![]() Even with reserves worth 25% of GDP, South Korea had to turn to the Fed for an emergency liquidity line of dollars.Īmong emerging economies, China plays by far the most influential role in the global monetary system. That logic was reinforced in the crisis of 2008, when countries with lots of reserves, such as China or Brazil, fared better than those with less in hand. Governments in many emerging economies concluded that in an era of financial globalisation safety lay in piling up huge reserves. Foreign money fled, setting off deep recessions. Just as important are the scars left by the financial crises of the late 1990s. Many of them are worried about level as well as speed: they want export-led growth-and an undervalued currency to encourage it. They do this in part because governments do not want their exchange rates to soar suddenly, crippling exporters. When capital pours in, central banks buy foreign exchange to stem their rise. Countries are loth to let their currencies move freely. But most of these floats are heavily managed. About 40% of them officially float their currencies, up from less than 20% 15 years ago. On paper, their currency regimes are also becoming more flexible. Net private flows to these economies are likely to reach $340 billion this year, up from $81 billion a decade ago. Capital controls were lifted three decades ago and financial markets are highly integrated.īroadly, emerging economies are also seeing a freer flow of capital, thanks to globalisation as much as to the removal of restrictions. Most rich countries' currencies float more or less freely-although the creation of the euro was plainly a step in the opposite direction. Today's system has no tie to gold or any other anchor, and contains a variety of exchange-rate regimes and capital controls. The system collapsed in 1971, mainly because America would not subordinate its domestic policies to the gold link. Capital mobility was limited, so that countries had control over their own monetary conditions. In the Bretton Woods regime currencies were pegged to the dollar, which in turn was tied to gold. The system collapsed largely because it allowed governments no domestic monetary flexibility. Under the classical 19th-century gold standard, capital flows were mostly unfettered and currencies were tied to gold. If capital can flow across borders, countries must choose between fixing their currencies and controlling their domestic monetary conditions. ![]() ![]() The shape of any monetary system is constrained by what is often called the “trilemma” of international economics. The question is: what improvements are feasible? Ever since the post-war Bretton Woods system of fixed but adjustable exchange rates fell apart in the 1970s, academics have offered Utopian blueprints for a new version. Such a debate has in fact been going on sporadically for decades. He wants a debate “without taboos” on how to improve an outdated system. Nicolas Sarkozy, the country's president, wants to put international monetary reform at the top of the group's agenda for the next year. Many politicians argue that a financial system in which emerging economies can suffer floods of foreign capital (as now) or sudden droughts (as in 1997-) cannot be the best basis for long-term growth.įrance, which assumes the chairmanship of the G20 after the Seoul summit, thinks the world can do better. Financial crises have become more frequent in the past three decades. The third complaint is about the scale and volatility of capital flows.
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