1. THE COMING GLOBAL MONETARY DISORDER Benjamin J. Cohen University of California, Santa Barbara Remarks Prepared for presentation at the Fundación Rafael del Pino, Madrid, Spain, 19 May 2014

2. EXECUTIVE SUMMARY Question: What is the outlook for the international monetary system (IMS)? Answer: More disorder (most likely scenario) Why? A growing sense of complacency, due to – ◦Overestimation of economic recovery ◦Underestimation of future risks What can we do? ◦Strengthen commitment to growth ◦Promote greater policy cooperation But can we do it?

3. CAVEAT Not everyone is complacent ◦IMF (“Global Agenda”, April): “The global recovery has strengthened but remains far from robust” ◦The Economist (May 10 th )warns that we “still face testing times” ◦Christine Lagarde (May 12 th ) warns of “deceiving calm” But the signs of growing complacency are evident ◦Capital is flowing back into European periphery; sovereign borrowing cost are dropping; spreads are narrowing ◦Ireland and Portugal have made a “clean exit” from their bail-outs, forgoing the safety net of a precautionary line of credit ◦Central banks are pulling back (US, UK) or standing pat (ECB)

4. THE GOOD NEWS The economic recovery is gaining strength ◦Latest forecasts (IMF): 2013 20142015 ◦World3.03.63.9 ◦USA1.92.83.0 ◦Euro area-0.51.21.5 ◦Germany0.51.71.8 ◦France0.31.01.5 ◦Italy-1.90.61.1 ◦Spain-1.20.91.0 ◦United Kingdom1.82.92.5 ◦Japan1.51.41.0 ◦China7.77.57.3

5. THE BAD NEWS Growth projections may be too optimistic Even if accurate, they are hardly impressive ◦Global growth is still well below potential ◦GDP in most advanced economies is still below 2008 ◦Unemployment is still very high ◦Threat of deflation (“lowflation”) ◦“Secular stagnation”? Worst: they underestimate three major dangers in the IMS ◦Exchange rate instability (“currency wars”?) ◦Peak currency competition (dollar crisis?) ◦Erosion of monetary cooperation (breakdown of governance?)

6. CURRENCY WARS? An old problem: temptation to manipulate exchange rates In principle, outlawed by IMF Article IV, “firm” surveillance In practice, surveillance is ineffectual; governments do what they want (“dirty floats”) ◦Direct intervention in the foreign-exchange market ◦Monetary policy (interest rates, money supply) ◦Capital controls

7. WHY IS SURVEILLANCE INEFFECTIVE? Motivations are difficult to assess: Is an ER movement the aim of policy or an incidental b- product? Examples: ◦US: Federal Reserve’s QE2 ◦Japan: “Abenomics” ◦China (and other Asian nations): reserve accumulations – insurance or ER manipulation? State sovereignty: IMF has little real authority to enforce the rules Result: danger of renewed currency war ◦Aggravated by sluggish recovery ◦In turn, retards recovery (inhibiting adjustment, increasing volatility and uncertainty )

8. DOLLAR CRISIS? Central role of the US dollar: good or bad? ◦Good: Stabilizing “hegemon” ◦Bad: Destabilizing monopolist (“exorbitant privilege”) ◦Answer: both (but more good than bad) Trend toward a multi-currency system: good or bad? ◦Good: Would impose discipline on the US ◦Bad: Would provoke competition, destabilizing shifts of confidence ◦Answer: again both (more bad than good) Real question: Are there any real challengers to the dollar? ◦Two possible candidates: euro and yuan (renminbi, RMB) ◦Answer: NO, BUT… ◦Neither is a threat to the dollar at the global level ◦But each will challenge at the regional level (an “asymmetrical multipolar system”) ◦Challenge will be sufficient to threaten greater instability

9. THE EURO Potential as an int’l currency remains unrealized. Why? Flawed from the start – an asymmetrical distribution of authority (monetary centralization, fiscal decentralization) – hence no credible mechanism to deal with internal payments problems Ideal solution: a “transfer union” (mutualization of risk) on model of US ◦Balanced budgets ◦Bail-out ban ◦Automatic transfers European “solution” – combination of ◦Fiscal limits (Stability and Growth Pact, now Fiscal Compact) ◦Bail-out ban, now European Stability Mechanism (ESM) ◦But NO automatic transfers Result: persistent crisis, anti-growth bias

10. ANTI-GROWTH BIAS Without automatic transfers, each imbalance crisis must be negotiated Adjustment pressures tend to fall on debtors ◦[Keynes: “the process of adjustment is compulsory for the debtor and voluntary for the creditor”] Only choice: “internal devaluation” (austerity) – hence an anti-growth bias In short, an updated version of the gold standard without gold – a “cross of euros.”

11. IS THE EURO DOOMED? Neither success nor failure ◦Centripetal force: commitment to union, fear of consequences of breakdown ◦Centrifugal force: imperatives of sovereignty ◦Result: an uneasy, untidy series of compromises, limiting the appeal of the euro as an alternative to the dollar Nevertheless, the euro will be a challenge to the dollar in its own neighborhood – a potentially destabilizing competition

12. THE YUAN A serious rival to the dollar? Clearly a Chinese goal China’s strategy (choice of goals) ◦Two tracks ◦Trade (swap agreements, trade invoicing) ◦Finance (bank and bond markets in Hong Kong) ◦Well conceived – stresses most important roles (trade, investment, reserves) China’s statecraft (choice of means) – less well conceived ◦Until now, reliance on China’s growing economic weight (“gravitational pull”) ◦Missing: financial development; rule of law ◦Why? Inconsistent with Chinese political economy model (“Beijing Consensus”) Conclusion: Will not be a serious threat to the dollar for a long time – but like the euro, will be a challenge to the dollar in China’s own neighborhood – a potentially destabilizing competition

13. GOVERNANCE Basic requirement: A minimum degree of policy cooperation; impossible without – ◦A consensus on basic principles ◦Effective leadership by dominant monetary powers ◦Neither seems evident today IMF ◦Promising reforms were agreed in 2010 ◦But implementation has been blocked by the US (specifically, Republicans) ◦Result: pressures by BRICS, others to move on without the US – IMF could split Group of 20 ◦Newly designated as the central locus of monetary governance ◦But few accomplishments ◦Reasons ◦Lack of consensus ◦Few have been willing to take the responsibility to lead ◦Result: drift, risk of rising policy conflict

14. CONCLUSION No reason to be complacent ◦Improvements have been overestimated ◦Risks are underestimated High risk of growing monetary disorder What can we do? ◦Strengthen commitment to growth ◦Promote greater policy cooperation Easier said than done Be prepared!