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2014 | OriginalPaper | Chapter

13. The Global Monetary System

Authors : Farrokh Langdana, Peter T. Murphy

Published in: International Trade and Global Macropolicy

Publisher: Springer New York

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Abstract

In this final chapter we apply much of what we have previously learned as we examine several contemporary policy topics. We explore the policy of foreign exchange sterilization, and its contribution to the global imbalances that have built up in the early part of this century. The US dollar-Chinese yuan saga and controversy are explored at length. We discuss the US dollar's role as the world's reserve currency, and the potential challengers to the dollar's dominance. Finally, we explore a topic that has garnered attention in recent years as central banks have taken to increasingly unorthodox experimentation: fiat currency and the gold standard.

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previous chapter Capital Flows: Perfectly and Imperfectly Mobile Capital

China’s capital mobility is imperfect; we use the horizontal BOP here to keep the graph simple. The results are not meaningfully affected.

The RRR was, for example, increased from 18.0 % to 18.5 % in November 2010, effectively taking 350 billion yuan out of circulation. Source: Aileen Wang and Simon Rabinovitch, “China Raises RRR Again as Inflation Fight Intensifies,” Reuters, Nov 19, 2010, 7:34 ET

Neely, “Capital Controls,” 6

Exports of goods and services accounted for 31 % of China’s GDP in 2011 (source: World Bank). Among the world’s ten largest economies (taking the EU as a unit), China’s export-to-GDP ratio is only matched by Mexico, at 31 %. Others: Canada (29 %), Russia (28 %), India (25 %), Australia (21 %), Japan (15 %), European Union (14 %), United States (13 %), and Brazil (12 %)

Food consumption in China accounted for 32.9 % of household expenditure in 2009. Compare to 6.2 % in the US, 11.4 % in Germany, 14.9 % in Japan, 24.7 % in Brazil, and 35.4 % in India. Source: USDA Food CPI and Expenditures: 2009

Alice Y. Ouyang, Ramkishen S. Rajan, and Thomas D. Willett, “China as a Reserve Sink: The Evidence from Offset and Sterilization Coefficients,” Hong Kong Institute for Monetary Research, Working Paper 102007, October 2006, 23. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1008194. Accessed November 12, 2012. Chenying Zhang obtains that between 79 % and 93 % of foreign exchange is sterilized. Chenying Zhang, “Sterilization in China: Effectiveness and Cost,” The Wharton School, University of Pennsylvania Finance Department, September 2010, 23

Other methods are also used from time to time, such as “credit ceilings.” Fan Geng, “China’s Monetary Sterilization,” China Daily, November 30, 2010

Chenying Zhang (2010), using only relative interest rates on US Treasuries and interest rates paid on Chinese bank reserves and sterilization bonds, estimates that China’s net returns from sterilization between 2003 and 2010 were positive. His calculations do not incorporate the steady USD depreciation against the RMB, the illiquidity premium described above, or the effect of changes in interest rates on the market value of USD holdings. Chenying Zhang, “Sterilization in China: Effectiveness and Cost,” The Wharton School, University of Pennsylvania Finance Department, September 2010, 23

C. K. Prahalad and Stuart L. Hart, “The Fortunate at the Bottom of the Pyramid,” strategy + business issue no. 26 first quarter 2002. (McLean, VA: Booz Allen Hamilton), 2002

The experiences of Malaysia in the 1990s and Japan in the late 1960s illustrate the point. A discussion of these events and the various effects of PBC sterilization may be found in John Greenwood, “The Costs and Implications of PBC Sterilization,” Cato Journal 28,No. 2 (Spring/Summer 2008): 205–217

$2 billion to $4 billion per day as of 2012–2013

See Chap. 9.

It should be noted that some, including Fed Chairman Ben Bernanke, reject the “twin deficits” hypothesis that budget deficits cause current account deficits, pointing to Germany and Japan which run trade surpluses and fiscal deficits.

Mark J. Perry, Ph.D., Chap. 14:Modern Macroeconomics and Monetary Policy, ECONOMIC$ 201 - PRINCIPLES OF MACROECONOMIC$ (Flint: University of Michigan). Accessed March 31, 2011, http://spruce.flint.umich.edu/~mjperry/macro14.htm

This is the “liquidity trap,” which we have discussed in earlier chapters.

Ronald McKinnon, “The Latest American Export: Inflation”, Wall Street Journal, January 18, 2011, accessed November 18, 2012. http://online.wsj.com/article/SB10001424052748704405704576064252782421930.html

Phil Flynn, “Bernanke Says Unfair to Blame Inflation on QE,” Futuresmag.com, February 4, 2011, accessed March 31, 2011, http://www.futuresmag.com/News/2011/2/Pages/Bernanke-says-unfair-to-blame-inflation-on-QE.aspx

Li Yanping, “China’s Inflation Exceeds Target for Fourth Month, Adding Rates Pressure,” Bloomberg.com, February 15, 2011, accessed March 31, 2011, http://www.bloomberg.com/news/2011-02-15/china-s-january-consumer-prices-increase-4-9-producer-prices-climb-6-6-.html

Greenwood, “The Costs and Implications of PBC Sterilization,” 208

Mexico and Canada are excluded as their proximity and volume of interindustry trade are atypical among US trading partners. Data from US Census Bureau and CIA World Factbook, calculations by authors. Exponential regression is used in Fig. 13.17 as this method provides a better fit given the great heterogeneity between developing and advanced countries. Fig. 13.18, which includes only developing Asia, uses a linear regression with an intercept of zero, as these countries are more homogenous.

Per-capita exports to China following the regression lines in Figs. 13.18 and 13.19 would be $133 and $113, respectively, instead of the actual $77. This equates to a potential increase of 47–70 % if China followed the trend. US Exports to China in 2011 were $103.9 billion. Imports were $399.4 billion.

Greenberg, “The Costs and Implications of PBC Sterilization,” 206

See Chap. 4.

Magnitude of Counterfeiting and Piracy in Tangible Products: An Update (OECD: November 2009), 1. Other estimates range higher, for example, the International Chamber of Commerce put the value at $600 billion. The OECD study remains as of early 2013 the most authoritative, comprehensive, and rigorously documented effort to determine the scope of counterfeiting and piracy.

The OECD’s GTRIC-e index is a measurement of the relative intensity of counterfeit and pirated exports of a given economy. The highest ratings for the 1999–2005 period went to China–Hong Kong SAR (2.86), Laos (2.85), Afghanistan (2.35), the United Arab Emirates (2.06), North Korea (1.94), Togo (1.92), Kyrgyzstan (1.77), Tokelau (1.76), Lebanon (1.73), Pakistan (1.66), and Cyprus (1.54). China’s economy dwarfs the others on the list (Hong Kong is included in the figure as it is a significant passageway for goods moving in and out of China). By way of comparison, the GTRIC-e ratings for several other large economies include the USA (0.14), Japan (0.05), Germany (0.04), Brazil (0.13), India (0.64), Russia (.0.26), Australia (0.09), and Mexico (0.07). Source: OECD Magnitude of Counterfeiting and Piracy, 6. The majority of customs seizures in the USA for counterfeit and pirated goods each year originate in China (source: U.S. Customs and Border Protection and US Immigration and Customs Enforcement, Report on 2011 Counterfeit Seizures).

The Economic Impact of Counterfeiting and Piracy (OECD: 2007), 29. Note that while many of these items are manufactured overseas for US firms, royalty and license fees, which flow to the US patent and copyright holders, are an export item within the current account.

The Economic Impact of Counterfeiting and Piracy (OECD: 2007), 15

With growth at the 12 % trend from $250 billion in 2007, the 2012 figure would be $440 billion. Assuming at least an equal amount is lost from domestic and internet theft and piracy outside of the United States, this brings the total figure to $880 billion. Given the USA’s economic leadership in most of the areas subject to the most severe losses, it is not unreasonable to assume the USA bears at least 50 % of the total loss, or $400+ billion. The 2011 US trade deficit was $466 billion. (At a minimum, the US share of the theoretical $880 billion figure should equate to its share of world GDP, which would put the US loss at $190 billion.)

China, Russia, and a core handful of nations account for the vast bulk of the activity in collecting US information and technology. It is notable that the USA runs a trade deficit with the largest of these countries. See Annual Report to Congress on Foreign Economic Collection and Industrial Espionage FY07 (Office of the National Counterintelligence Executive, 10 September 2008). It should be noted that information gathering of this nature is a near-universal practice.

See James McGregor, China’s Drive for Indigenous Innovation, a Web of Industrial Policies, US Chamber of Commerce, 2009, which analyzes China’s policies of “assimilation, absorption, co-innovation and re-innovation” in this context. It should be noted however that the historical evidence is fairly clear that the USA itself engaged in wholesale appropriation of intellectual property without compensation during the post-Revolutionary era, primarily from Great Britain. At the time, the British were just as indignant at the violation of their patent rights and theft of their trade secrets as the USA is today. Peter Andreas makes a convincing argument that this activity was central to the extraordinary pace of development during the USA’s early years in Peter Andreas, Smuggler Nation: How Illicit Trade Made America, Oxford University Press, 2013.

Ben Bernanke coined this term in a 2005 speech, “The Global Saving Glut and the U.S. Current Account Deficit.” Remarks by Governor Ben S. Bernanke at the Sandridge Lecture, Virginia Association of Economists, Richmond, Virginia, March 10, 2005, accessed November 18, 2012. Bernanke blamed high savings rates worldwide for a global savings glut; the authors agree here with economist John Taylor’s critique that the empirical evidence rather points to a savings glut of sorts in developing Asia and a concurrent savings deficit in the United States. We present this interpretation of the “savings glut” here. See John B. Taylor, “The Financial Crisis and the Policy Responses: An Empirical Analysis of What Went Wrong,” November 2008, 5, accessed November 18, 2012. http://www.stanford.edu/~johntayl/FCPR.pdf

Currency and Government Debt may be seen simply as two forms of Sovereign Liabilities, the difference being that the former pays no interest. See John Hussman, Ph.D.,“Why the Federal Reserve is Irrelevant,”, Hussman Funds Research & Insight, August, 2001, accessed November 18, 2011, http://www.hussmanfunds.com/html/fedirrel.htm

A thorough exposition of the topic is given in John Nugeé (2000). Foreign Exchange Reserves Management, Bank of England Centre for Central Banking Studies Handbooks in Central Banking No. 19.

Mike Shedlock. “US Dollar About to Lose Reserve Currency Status–Fact or Fantasy?” Mish’s Global Economic Trend Analysis, February 28, 1011, accessed November 18, 2012, http://globaleconomicanalysis.blogspot.com/2011/02/us-dollar-about-to-lose-reserve.html

United States Treasury Office of International Affairs, “Appendix 1: An Historical Perspective on the Reserve Currency Status of the US Dollar,” Report to Congress on International Economics and Exchange Rate Policies, October 15, 2010

Craig Elwell, “The Dollar’s Future as the World’s Reserve Currency: The Challenge of the Euro,” Congressional Research Service Report for Congress, July 10, 2007, 7

Barry Eichengreen, “Sterling’s Past, Dollar’s Future: Historical Perspectives on Reserve Currency Competition” (Tawney Lecture delivered to the Economic Historical Society, Leicester, United Kingdom, April 10, 2005), 7

Eichengreen, “Sterling’s Past, Dollar’s Future: Historical Perspectives on Reserve Currency Competition,” 3

Avinash Persaud “When Currency Empires Fall,”, October 11, 2004, www.321gold.com . Accessed February 18, 2011

Data sources: $9 trillion in total foreign exchange reserves as of December 2010 per IMF; $1.3 trillion in gold reserves as of December 2010 per World Gold Council, calculated from 29,978 tons at US $1,400 per ounce; $13 trillion global monetary base per Natixis implies a ratio of 9/13 foreign exchange to total central bank assets.

Eichengreen, 2005, “Sterling’s Past, Dollar’s Future: Historical Perspectives on Reserve Currency Competition,”10

Eichengreen, 2005 “Sterling’s Past, Dollar’s Future: Historical Perspectives on Reserve Currency Competition,” 10

After Belgian-American economist Robert Triffin (1911–1933), who predicted the failure of the Bretton Woods system based on this inherent conflict

The United Kingdom was a net debtor following World War I while sterling retained its prominence for a long time after.

Eichengreen, “Sterling’s Past, Dollar’s Future: Historical Perspectives on Reserve Currency Competition,” 1

“China and the Dollar,” Wall Street Journal, March 26, 2009. US Treasury Secretary Geithner offered that he was “quite open” to the suggestion of Chinese Central Bank Governor Zhou Xiaochuan that an international currency supplant the dollar as the world’s reserve currency.

We count the euro area as a single economy. China ranks #2 among sovereign nations after the United States.

This insight is attributed to Shedlock, “US Dollar.”

“Special Drawing Rights (SDRs) Factsheet,” International Monetary Fund, December 9, 2010, accessed November 18, 2012, http://www.imf.org/external/np/exr/facts/sdr.htm

Shedlock, “US Dollar”

Source: Standard & Poor’s. See also “Hopes Raised, Punches Pulled,” The Economist February 10, 2011

The phrase was originally credited to Charles De Gaulle, but recently has been attributed to Valery Giscard d’Estaing. Brad De Long, “Exorbitant Privilege,” February 22, 2005

Richard Clarida estimates that the dollar’s decline from 2002 to 2007 reaped the USA a capital gain of $1 trillion in this manner. Richard Clarida, “With Privilege Comes..?” Global Perspectives, Pimco, October 2009

Elwell, “The Dollar’s Future,” 2

Elwell, “The Dollar’s Future,” 4. See also Barry Eichengreen and Donald J. Mathieson, “The Currency Composition of Foreign Exchange Reserves: Retrospect and Prospect,” IMF Working Paper, July 2000, 6

The US ranks 4th in competitiveness behind Sweden, Switzerland, and Singapore but is 1st among large economies. The next five large economies are Japan (6th), Canada (10th), Taiwan (13th), Australia (16th), and the EU (20th overall by weighted GDP as calculated by the authors). Data source: Klaus Schwab, ed, The Global Competitiveness Report 2010–2011 (Geneva: World Economic Forum, 2010), 15

Hussman, “Why the Federal Reserve Is Irrelevant,”, Hussman Funds Research & Insight, August 2001

Gold remains quite scarce—consider: if the entirety of the world’s outstanding 187,000 t of gold were divided equally among the world’s 8 billion people, each would receive but 0.75 oz of gold (total tonnage of 187,000 per World Gold Council, 2011).

Richard Brown, A History of Accounting and Accountants (New York: Cosimo, Inc.), 2004. Originally published by Augustus M. Kelley Publishers, 1905

The authors are deeply indebted to Ralph T. Foster, whose indispensable Fiat Paper Money: The History and Evolution of our Currency (Berkeley: Ralph T. Foster, 1991) provided much of the historical information presented in this section.

Douglas Irwin presents a convincing case that the sterilization activities of the United States and especially France in the late 1920s and early 1930s were the trigger that initiated the massive world deflation and ensuing Great Depression. Douglas A. Irwin, “Did France Cause the Great Depression?” Dartmouth College and NBER, November 15, 2010

As few things said to be “impossible” remain that way over the long term, we note that the exception would be, of course, if someone were to discover the legendary “Philosopher’s Stone” (or its equivalent inside a fusion reactor), which turns lead into gold, rendering gold intrinsically worthless.

Johan Palmstruch managed to make it a full 2 years, to 1663 A.D., before his bank failed from overprinting of notes, and he died in prison in 1670. Nevertheless, his introduction of gold-backed paper money laid the foundation for the dominant monetary system in the West for the next 300 years.

Eichengreen, “Sterling’s Past, Dollar’s Future: Historical Perspectives on Reserve Currency Competition”

Please see Chap. 7 of Langdana, Macroeconomic Policy: Demystifying Monetary and Fiscal Policy, for a discussion of the German hyperinflation during the Weimer Republic.

France actually chose a rate that proved to be undervalued; its weak exchange rate led to an accumulation of gold which would be the cause of serious conflict between finance ministers in the interwar period and may even have caused the Great Depression. See Irwin, Did France Cause the Great Depression?, Dartmouth College and NBER, November 15, 2010.

Keynes’ prophetic The Economic Consequences of the Peace (1919) discusses the impossible conditions imposed on Germany, and their inevitable results (written before the fact), in excellent detail.

The inherent conflict between acting as a responsible manager of the world’s currency standard while simultaneously pursuing domestically driven monetary policy objectives became known as the Triffin dilemma.

Title: The Global Monetary System
Authors: Farrokh Langdana
Peter T. Murphy
Publisher: Springer New York
Book: International Trade and Global Macropolicy
Print ISBN: 978-1-4614-1634-0

Electronic ISBN: 978-1-4614-1635-7

Copyright Year: 2014
DOI: https://doi.org/10.1007/978-1-4614-1635-7_13