Power and Imbalances in the Global Monetary System

The global monetary system — the structure that governs financial relations between nations and their macroeconomic policies — plays an indispensable role in the smooth functioning of the world economy and even world politics. As Richard Cooper noted during the global monetary turmoil of the 1970s,

[w]hen monetary relations go well, other relations have a better chance of going well; when they go badly, other areas are likely to suffer too. Monetary relations have a pervasive influence on both domestic and international economic developments, and history is strewn with examples of monetary failure leading subsequently to economic and political upheaval.

(Cooper 1975: 63)

The monetary volatility of the 1970s was widely linked to the breakup of the Bretton Woods regime and the shift from fixed-but-adjustable exchange rates toward flexible ones, which had loosened the constraints on national monetary policies. When the advanced market economies (AMEs) removed their capital controls during the 1970 and 1980s, the re-emergence of free capital mobility and global finance further contributed to the idea that the global monetary system had transformed into an increasingly instable “non-system” (Gilpin 1987; Helleiner 1994).

This chapter develops an analytical framework that combines the concepts of the international monetary power literature with those of the comparative capitalism literature. It will be argued that these two strands of literature can complement and reinforce each other, thereby offering new insights that will be elaborated in subsequent chapters. While both were developed in the 1990s and 2000s and share an interest in the issue of national autonomy in the context of financial globalization, there has been a remarkable lack of interaction between both approaches. The international monetary power literature has mostly focused on the international distribution of costs associated with the adjustment of nations to unsustainable balance-of-payments disequilibria — costs that are usually defined in terms of lost macroeconomic autonomy. Scholars working in this field have explained why these costs are typically distributed asymmetrically between nations and why some nations are able to avoid costs and/or deflect them onto weaker nations in the global monetary system. One of their main insights is that the capacity of a nation to avoid the burden of adjustment depends on the extent to which its currency is internationalized. At the same time, however, the literature on international monetary power has neglected the important role of domestic institutions in determining the specific macroeconomic goals nations pursue as well as for understanding the outcome of the international struggle over the distribution of adjustment: it will be maintained in this chapter that the domestic sources and purpose of a nation’s international monetary power are closely linked to the specific institutions of its national model of capitalism.

In this chapter I re-examine the instability of US monetary hegemony from a comparative capitalism perspective. As noted in the previous chapter, a prevailing interpretation in the international monetary power literature is that the main source of global instability arising from the monetary hegemony of the United States is the excessive growth of foreign liabilities associated with its structural power to delay adjustment, which tend to undermine foreign confidence in the stability of the dollar as the world’s key currency (KC). There appears to be a strong correspondence between this international monetary power interpretation of the instability of US monetary hegemony and the “Triffin dilemma” interpretation, which argues that growing foreign demand for dollar liquidity can only be met by growing US external deficits that risk eroding foreign confidence in the dollar. An important yet neglected question is whether the increase in foreign demand for dollar-denominated liquid assets — particularly in EMEs — has been exogenous or endogenous to the capacity of the United States to avoid the burden of adjustment: has the increase of dollar accumulation in EMEs since the second half of the 1990s been the cause or the effect of the macroeconomic expansion and the rise in the US current account deficit? By neglecting this question scholars of US monetary power have not only been able to account for the instability of US monetary hegemony but also failed to challenge the global savings glut (GSG) theory, which claims that the rise in the US current account deficit was caused by excess savings in EMEs and an associated exogenous rise in dollar accumulation (e.g. Bernanke 2005; Dumas 2008: Ferguson and Schlumarick 2007: Wolf 2008).

The previous chapter has argued that the global monetary system remains largely centered around the dollar and the United States, which has played the role of consumer-of-last-resort over the past two decades by pursuing finance-led growth. In this chapter I focus on the international monetary power of the Eurozone member states, which will allow me to explain why the Eurozone has not functioned as an engine of global demand since the introduction of the euro. One of the principle motivations behind the introduction of the euro was to strengthen the monetary power of its member states. As a patrician currency whose action radius would spawn a region that almost matches the United States in terms of GDP, the euro was meant to strengthen the macroeconomic autonomy of its member states by decreasing their vulnerability to external monetary developments. Given the laudability of the motivation behind its creation, it is very surprising that systematic examinations of the impact of the EMU on the monetary power of its member states are in short supply in the IPE literature. For those IPE scholars that have paid attention to this issue, the prevailing understanding seems to be that EMU member states have more or less equally benefited from the creation of the euro in terms of monetary power. This understanding is based on the notion that the EMU regime is a symmetric system of European monetary cooperation entailing two empowering mechanisms that would support the macroeconomic autonomy of its member states to an equal degree.

As I have shown in Chapter 2, foreign exchange accumulation by EMEs has been highly conducive to supporting the macroeconomic autonomy of the United States to adopt a financed-led growth regime. China, which had amassed more than US$3.3 trillion in reserve assets by the end of 2012, accumulated reserves on an unprecedented scale over the past decade. China became increasingly vulnerable to external monetary developments as a result of its extraordinary foreign exchange accumulation: not only was the balance sheet of the People’s Bank of China (PBoC) increasingly exposed to an exchange rate appreciation of the renminbi against the dollar; these reserves also reflect an excessive export orientation of the Chinese economy that made it increasingly vulnerable to a downfall in global demand. Why did China accumulate so many reserves that seem to have increased its external monetary vulnerability? By arguing that these reserves have strengthened the macroeconomic autonomy of China to adopt an export-led growth regime, the prevailing interpretation among scholars of IPE appears to be that the benefits of foreign exchange accumulation have exceeded the costs. While these scholars have also drawn attention to the presence of external constraints on the pursuit of China’s monetary power, they have usually narrowed down their argument to the claim that its currency policy has been shaped by its desire to maintain the value of its foreign exchange reserves and to support the competitiveness of its export sector — a claim that follows from Jonathan Kirshner’s concept of “entrapment” (Kirshner 1995).

In the previous chapters I have examined the monetary power of the United States, EMU member states and China behind the background of rising current account imbalances. I have argued that the rise of the global imbalances was mostly a manifestation of US structural monetary power, which allowed the United States to adopt a finance-led growth regime in which the Federal Reserve’s accommodating monetary policy played a prominent role: monetary expansion not only fueled the US trade deficit by encouraging an expansion of credit and asset price inflation in the US economy; it also fueled private capital flows to EMEs, which were mostly recycled by their central banks as dollar accumulation. The Eurozone played a negligible role in the generation of global demand in the years preceding the global financial crisis (GFC): I showed that the EMU’s non-accommodating macroeconomic governance regime strengthened the autonomy of the region’s CMEs to pursue export-led growth and run persistent and — especially in the case of Germany — increasing trade surpluses at the same time as undermining the external competiveness of the MMEs and forcing these countries to run increasing trade deficits. Finally, I argued that China’s rising foreign exchange reserves fueled a growing imbalance between corporate investment and household consumption in its growth regime by entrenching the influence of the SOE sector in the domestic political economy, thereby constraining China’s autonomy to reduce its external monetary dependence by rebalancing growth and making its support of the dollar even more ingrained than existing accounts of its entrapment have suggested.

In this book I have formulated a comparative capitalism perspective on relations of international monetary power to account for the rise in the global current account imbalances and the regional imbalances of the Eurozone. One of the key insights of the international monetary power literature is that the asymmetric distribution of autonomy is intrinsically connected to the asymmetric structure of the international currency system, in which the dollar remains the only “top currency” of the global economy. Because the dollar remains the most desired currency to be used for the denomination and settlement of cross-border trade, investment and foreign exchange reserves, the United States continues to wield hegemonic power in the global monetary system. From this perspective, the rise in the US current account deficit reflects the unique macroeconomic autonomy that comes with issuing the world’s key currency: the fact that the United States accumulated foreign liabilities on an unprecedented scale over the past two decades reflects its unique capacity to delay the burden of adjustment by attracting foreign capital and savings, which follows from the desire and need of foreign private and public actors to use the dollar as an internationally accepted means of exchange, unit of account and store of value. For this reason, the unparalleled rise in the US external deficits is not a manifestation of hegemonic decline but of the persistent structural monetary power the United States continues to enjoy.