IMF economists lament dollar-based financial system


Plea to Reduce Demand for Dollar Reserves

By Krishna Guha
Financial Times, London
Wednesday, November 11, 2009

WASHINGTON -- The world should try to mitigate flaws in the dollar-based global monetary system by reducing demand for dollar reserves and exploring alternative reserve assets, a group of economists from the International Monetary Fund said on Wednesday.

The economists said the crisis had "brought to the fore" long-standing concerns about a system based on a single core currency issued by one country.

They said the dollar-based system "suffered inherent weaknesses."

The US, at the centre of the system, was under pressure to run large current account deficits in order to supply the world with the dollar assets it wants, they said, while there was no effective discipline on either the US or countries such as China that have big external surpluses to adjust their policies.

The report was published by the authors in their individual capacity and not endorsed by the IMF as an institution. But it comes amid renewed global focus on and dissatisfaction with the role of the dollar in the world economic system, following the experience of a crisis at the core rather than the periphery of the world system.

The IMF economists said the crisis highlighted the "scale and volatility of global capital flows" that led countries to accumulate reserves to protect themselves against a sudden reversal in capital.

But it also renewed questions about "anchoring the international monetary system on one country's currency" -- the dollar -- "given the origins of this crisis in the US heart of the global financial system."

They said the current system was "something of a non-system" because some economies maintained floating exchange rates while others pegged their currencies to the dollar.

The IMF economists proposed creating better alternatives that would allow countries worried about volatile capital flows to stop building up reserves.

These would include helping to create private-sector insurance-type markets to provide funds when they were needed, and an enhanced role for the IMF itself in providing reliable access to finance.

The IMF has already taken steps in this direction through the creation of a flexible credit line for well-run emerging economies. But the authors note that the fund's resources would have to be greatly increased to enable it to act as a credible lender of last resort for large economies.

The economists said reducing demand for dollar reserves would be only part of the solution. They said the world would also have to examine alternatives to the dollar as the dominant reserve asset.

This could include a move to a system in which the dollar shared its leading role with a few other currencies such as the euro and possibly China's renminbi. They also argued in favour of taking seriously the possibility that one day the the SDR, the IMF synthetic currency, might replace the dollar as the main reserve asset.

However, in order to do this they said issuers would have to create large-scale liquid markets denominated in SDRs. Moreover, they said moving to such as system would be much easier if countries with large dollar holdings could exchange these for SDRs in off-market transactions with the IMF.

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