Prospect of the International Monetary System

This is based on the speech by Prof. Zhang Zhixiang at Sejong University in Korea in May 2023.

Zhang Zhixiang, Former Director-General of International Department, PBoC, Former IMF Executive Director for China.

The three year long pandemic and over one year of the Russian-Ukraine military conflict have indeed created tremendous difficulties and uncertainties for the global economic development and the international monetary system. Global supply chain has split, production chain has also divided and international payment system has fragmented. Once again, the prospect of the international monetary system has become one of the important focuses in the economic and financial circles.

The international monetary system, known as the Bretton Woods System is a global public good with the main purpose as outlined in the IMF’s Articles of Agreement for promoting the expansion and balanced growth of international economic development by promoting exchange stability to maintain orderly exchange arrangement among members. However the dollar gold par value system expressed by US$35 for one ounce of gold collapsed in 1971. As early as in 1960, Robert Triffin published his famous paper known as Triffin Dilemma in which he tried to explain US dollar being the only reserve currency, it is impossible to maintain dollar par system. However, the real picture is that according to the statistics published by the UN trade and development committee, total volume of global commodities export reached US $50 billion in 1948, but it jumped to US$353.6 billion, registering an increase of more than 7 times, while the international gold reserve increased only from 30,183 tons to 36,575 tons with an increase of only 21% in the same period of time.

During the floating exchange rate in the post Bretton Woods System of more than 50 years, more than 100 financial crisis took place in the world. There have been four major types of crisis, namely the US dollar crisis and the Latin American financial crises, which are called the fundamental crises, as the economic targets and policies were mismatched and in conflict causing financial problems. The second type of crisis is named as “self-fulfilling”, which explains that as monetary policy has self-fulfilling character and in the process of transmission of monetary policy, the herding and contagion effect resulting in dissymmetrical phenomenon in the market. The North European banking crisis, the Japanese banking turbulence, the Mexican financial crisis, the Russian financial crisis and the Brazilian financial crisis all belong to this group. The third type of crisis is called “moral hazard” induced crisis. Enterprises borrow with banking sector’s guarantee. However international creditors evaluate risks according to the overall debt service ability of the economy. When the international creditors believe that the enterprises borrow too much, capital flow to the economy reduces sharply and very quickly. In Asia, domestic banks lend to enterprises based on sufficient collateral provided. When foreign banks found the Asian enterprises borrowed too much foreign currency debt, they began to reduce and even drastically cut down their financial presence within a very short time. The forth type of crisis is related to “asset bubble”. 2008 global financial crisis is a good example.

Here it should be pointed out that all the international financial crises are related to and even triggered by disequilibrium movement of liquidity. The Asian financial crisis can serve as a good example. The international multilateral banks lent to Indonesia, Korea, Malaysia and Thailand in 1971 US$ 18.4 billion totally, but in the second half of 1997 fell to negative US$ 20.3 billion and in the first half of 1998, fell further to negative US$46.9billion. The private capital net flow of capital to the same group of countries was US$65.2 billion in 1996, but it fell to negative US$20.4 billion in 1997 and to negative US$25.6 billion in 1998. Foreign direct investment to these countries was US$10.3billion, but fell to US$8.6 billion in 1998. Foreign investment in security markets to the same countries was US$12.9 billion, but fell to negative US$6 billion. Therefore, It has become a most important and urgent issue for the international community that capital flow under strict supervision and control.

How to supervise and deal with irregular flow of capital is not a new issue in the IMF. Back in 1972, when the Articles of Agreement of the Fund was amended, this issue was discussed and debated. However, this problem still exists. It has been suggested that international liquidity should be made a global public good. The international community is able to supervise and effectively cope with the disequilibrium flow of capital. He continued to propose that SDR should well be in the position to play the role of curbing the spill-over effect caused by the irrational flow of liquidity. Since financial crisis can involve 10 to 20 percent of world GDP. The IMF must have at least US$10 trillion reserve in SDRs. It is very difficult to envisage that SDR allocation can increase to that amount from current size of only about US$ one trillion. In IMF, allocation of SDR is an important issue which needs 85% of vote for approval. What is more, the distribution of SDR in the IMF is undertaken according to the percentage of member’s quota. It is very difficult if not impossible to implement it, though it can be a good proposal. Therefore it has further been suggested that a sequenced approach be adopted and formulated. For instance, some basis reform of SDR should be made, such as SDR can be used for trade settlement and SDR holders can transfer their SDRs to other members in the fund. It is believed that these reforms can well play an important role for paving the way for SDR playing the key role to facilitate making international liquidity a global public good in the international monetary system.

Serving as a 2nd best, regional monetary cooperation can well help protect the safety of the economies in the region. This is also recognized as a part of the sequenced agenda in making international liquidity a global public good. The Chiang Mai Initiative can continue to play a great role for promoting formation of greater monetary cooperation in the region. Sharing what we Asian countries have already learned from 1997 financial crisis, ASEAN plus three can play an active role promoting necessary reform of SDR as mentioned earlier. On March 28, when ASEAN financial ministers and central bank governors met, they called for trade settlement in local currencies. This ideal proposal can well be undertaken in the whole Asian region at large. It was reported that Malaysia had proposed for building up an Asian monetary fund, which can well help build a safety net for our region especially at time when we face unprecedentedly a great amount of uncertainties and challenges worldwide.

The IMF and the World Bank held their Spring meeting on April 10, 2023. The World Economic Outlook Report and the Global Financial Stability Report issued by the Fund have both emphasized that recent events in the United States have been a reminder that funding can disappear rapidly and even events at smaller banks can have systemic implications by triggering widespread loss of confidence and rapidly  spreading across the financial system, amplified by technology and social media. Once again, it is of vital and imperative significance to keep liquidity under effective control and make international liquidity a global public good.

The Asian Development Bank has made great contribution to the economic and social development in our region. We are happy to meet and discuss the prospect of international monetary system during the 56th ADB annual meeting in the beautiful city of of Incheon, Korea. Let us wish the current ADB annual meeting every success.

I also thank our host for hosting this seminar on this very good occasion.