27 September 2012
Ousmène Jacques Mandeng, Public Sector Group, UBS
The upcoming 2012 IMF Annual Meetings are unlikely to produce much excitement. Even though persistent talks about currency wars and renewed fears of protectionism may cause severe disruptions to international trade and investments and are normally the sorts of issues that raise alarm bells with policy makers. Exactly 40 years ago at the 1972 IMF Annual Meetings, then U.S. treasury secretary George Shultz did shock the international community with a bold plan to reform the international monetary system and end the special role of the dollar as a reserve currency. The U.S. proposal came after a complete disruption of the then existing monetary order and as key countries growing mistrust in the U.S. administration’s willingness to make necessary economic policy adjustments to ensure the stability of the dollar. Today, the dollar has mostly retained its dominant role in the system. At the same time, U.S. policies have probably never been more unsupportive of the dollar. Few expect the U.S. to embark on any bold reform plan any time soon and the IMF has retreated from earlier reform pledges. Yet, the case for reforming the system and rethinking the role of the dollar may have never been stronger.
The early 1970s were turbulent monetary times. In August 1971, U.S. President Richard Nixon announced the end of the Bretton Woods system of fixed exchange rates (par values) and the dollar’s convertibility into gold. Pressure for international monetary reform was substantial. Nixon addressed the 1972 IMF Annual Meetings to signal U.S. reform willingness and Shultz presented the outlines of the Volcker—then undersecretary of finance—Group plan including:1 Substituting the dollar for the IMF’s Special Drawing Right (SDR) to become the formal numeraire of the system, offering an exchange of existing reserve assets (dollars) into other reserve assets, eliminating the role of gold, transferring sovereignty to international institutions to manage the system. The reform efforts had not resulted in any major reform. In March 1973, generalised floating began as European Community countries introduced joint floating of their currencies against the dollar. The dollar depreciated by 37 percent and 43 percent against the yen and the mark, respectively, from their old par values through April 1978 when the IMF formalised the adoption of floating exchange rates. The 1972 effort was the last major attempt to reform the international monetary system.
The 1972 U.S. proposal was based in large part on the desire to impose greater balance of payments discipline. A system of par values linked to the then newly minted SDR was proposed but with wider more flexible margins. The plan criticised the fact that large surplus countries had little incentives to adjust and stressed that adjustment symmetry between surplus and deficit countries was essential for any lasting monetary system. Gains and losses in international reserves were considered as the key indicator to guide the need for adjustment: if reserves were too high the country would be expected to revalue its currency. The U.S. saw the possibility of a disorderly unwinding of dollar reserve holdings as a critical threat to the stability of the dollar. Symmetric adjustment, greater exchange rate flexibility and a lesser role of dollar assets and as such the dollar constituted the core elements of the U.S. plan.
The parallels with today are remarkable. The U.S. may be less discontent about the continued dominant role of the dollar but the built-up of international reserves most of which are claims on the U.S. are striking. Foreign exchange reserves stood at USD119 billion in 1972 compared with USD10400 billion today with the share of the dollar representing about 60 percent. The factors that have caused mistrust in the dollar in the past have been magnified as the Federal Reserves embarks on QE3 and the outlook for fiscal policy remains highly uncertain.
The 1972 U.S. plan 40 years on remains in essence astoundingly valid. However, it was based on the assumption that alternative currencies and assets existed to allow for an orderly exit of the dollar as the central pillar of the system. Then the mark and yen were emerging as major international currencies. Today this is not so clear. The euro and yen as obvious alternatives are unlikely to be able to credibly fulfil that role. Emerging markets currencies, certainly some of which are major international currencies-in-waiting do not seem or are not ready yet. The SDR has never meaningfully been embraced as a reserve asset. The need for a new numeraire for the international monetary system remains and would have to reflect the new geography of the world economy. This will require that major emerging markets currencies assume a greater role in the system earlier rather than later as possibly the only viable alternative. Shultz at the time said that “the nations gathered here have it in their power to strike a new balance in international economic affairs.” That holds even more so for today’s IMF Annual Meetings; the difference is though that the call for a new balance has become even more urgent.
1 The New York Times, “Text of Shultz talk before International Monetary Fund and World Bank,” 27 September 1972.