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Message from ADB's President Contributors Acknowledgements Executive Summary and Recommendations Jeffrey D. Sachs, Masahiro Kawai, Jong-Wha Lee, and Wing Thye Woo Paper Summaries (full papers downloadable) International Monetary Advisory Group Global Financial Crisis, its Impact on India and the Policy Response Nirupam Bajpai To What Extent Should Capital Flows be Regulated? Maria Socorro Gochoco-Bautista The Case for a Further Global Coordinated Fiscal Stimulus Willem Buiter Managing a Multiple Reserve Currency World Barry Eichengreen From the Chiang Mai Initiative to an Asian Monetary Fund Masahiro Kawai An Asian Currency Unit for Asian Monetary Integration Masahiro Kawai The International Monetary System at a Crossroad Felipe Larrain B. Towards a New Global Reserve System Joseph Stiglitz A Realistic Vision of Asian Economic Integration Wing Thye Woo An Asian Monetary Unit? Charles Wyplosz Will US fiscal Deficits Undermine the Role of the Dollar as Global Reserve Currency? If So, Should US Fiscal Policy be geared to Preserving the International Role of the Dollar? Yongding Yu International Monetary Working Group International Reserves and Swap Lines: the Recent Experience Joshua Aizenman, Donghyun Park and Yothin Jinjarak The Future of the Global Reserve System Daniel Gros, Cinzia Alcidi, Anton Brender, and Florence Pisani Renminbi Policy and the Global Currency System Yiping Huang Will the Renminbi Emerge as an International Reserve Currency? Jong-Wha Lee Asia's Sovereign Wealth Funds and Reform of the Global Reserve System Donghyun Park and Andrew Rozanov Reforming International Monetary System Kanhaiya Singh Designing a Regional Surveillance Mechanism for East Asia: Lessons from IMF Surveillance Shinji Takagi

4. Managing a Multiple Reserve Currency World

Barry Eichengreen

It is the thesis of this paper that a multiple reserve currency system is coming. The system for which we need to prepare is one in which the dollar, the euro and the renminbi will be consequential international and reserve currencies. The international monetary system is growing more multipolar because the world economy is growing more multipolar. After World War II, when the United States accounted for the majority of the industrial production of the non-Soviet world, it made sense that the dollar was the principal unit in which exporters and importers invoiced and settled their trade, in which international loans were extended, and in which central banks held their reserves. But this situation makes less sense today when the US accounts for only some 20 per cent of the combined output of countries engaged in international transactions. Because habits die hard, the dollar continues to play a disproportionately important role. But simply because this is true today does not mean that it will be true tomorrow. Countries that trade with and borrow from the euro area will increasingly seek to hold euros as reserves. Countries that trade with and borrow from the People’s Republic of China will similarly seek to hold renminbi, if not today then in the not-too-distant future.

Some warn that a multiple-international-currency system would be dangerously unstable. With dollars, euros and (eventually) renminbi all being substitutes for one another, their exchange rates will become dangerously volatile. Substitutability will create the temptation to shift erratically between them. Even a limited loss of confidence in the policies of one of the reserve-currency countries could cause central banks to rush out of its currency, aggravating financial difficulties in the problem country. The consequences for other reserve-issuing countries, which will see their currencies appreciate sharply, will be equally undesirable. A multiple-reserve-currency system, it is argued, would be an engine of instability.

This view is based on a mischaracterization of the behavior of central bank reserve managers. Reserve managers do not seek to maximize the return on their reserve portfolios in the manner of hedge-fund managers. They do not have the high-powered financial incentives of hedge fund managers – reserve managers are not compensated on a 2+20 scheme. They have less incentive to sell a currency simply because everyone else is selling. They can adopt a longer horizon because, unlike private fund managers, they do not have to satisfy impatient investors. They do not have to exceed their previous high-water mark in order to draw a paycheck.

What can be done, in terms of policy, to stabilize a multiple international currency system? Sound and stable policies on the part of the reserve-issuing countries would be the most important contribution. Chronic budget deficits, lax supervision and regulation of financial markets and institutions, and bubble-denying monetary policies could set the system up for a painful fall. An International Monetary Fund that refuses to pull its punches and exercises firm surveillance of large-country policies would help to prevent this.