Economic Globalization & the Next International Monetary Regime

Time for a Change?

For about the last 200 years the nations of the world have operated under different economic regimes. For most of the nineteenth century, until World War I, industrialized nations operated their economies under the auspices of what is known as the “Classical Gold Standard” and then from after World War II until 1971, those same nations participated in the Bretton Woods regime, which was essentially a modified version of the gold standard. After the end of the Bretton Woods regime, which took place during the height of the Cold War, the world moved into an unofficial economic system that was bipolar: the communist nations looked to the Soviet Union for economic support and inspiration while the United States came to dominate the rest of the world economically. With the collapse of the Soviet Union in 1991, the world’s economic order was temporarily thrust into chaos, as the once communist nations of eastern Europe struggled to assert their economic independence and many emerging nations contended for economic relevancy in a rapidly changing world.

Truly, there has been much change in the last twenty years in terms of both geo-politics and macroeconomics: the United States is still the most economically powerful nation-state, but emerging countries like China and India have threatened that power while old foes, such as Russia, have re-emerged to challenge American economic hegemony. Geo-political and economic developments across the world over the last twenty years have led many economists to postulate and theorize what the next major international monetary regime will be and how it will be implemented. As the power of emerging economies grows and the economic and monetary dominance of the dollar continues to diminish, it appears that a new monetary order where nations like India and China play a larger role in decision making is a foregone conclusion. But an examination reveals that the process towards a future international monetary regime is indeed very complicated and is therefore not certain and even economists argue that if the world were to adopt an international monetary regime in the future, it will be a long and gradual process.

The Post-Bretton Woods Economic Order

After the collapse of the Bretton Woods regime in 1971, the world’s economic order continued to operate in a similar way, with the notable exception that the nations that took part in the Bretton Woods system no longer backed their currency with gold. The communist nations, which were never part of Bretton Woods, continued to look to Moscow for economic marching orders while the United States continued to wield immense power, both politically and economically. The post-Bretton Woods world economic order and especially the post-Cold War order have been marked by multilateralism in both monetary policies and trade.

The evolution of multilateral trade agreements has followed a path that is closely linked with the formation of international monetary systems. After World War II, when the Bretton Woods regime was being established, many of the same nations signed the General Agreement on Tariffs and Trade (GATT), which sought to facilitate trade among member nations through its bylaws. When the Bretton Woods regime collapsed, GATT continued on and was augmented with other agreements such as the North American Free Trade Agreement (NATFA) in 1993 and eventually the World Trade Organization (WTO), which has effectively replaced GATT. Currently, despite considerable opposition from both the left and right wings of the political spectrum, the WTO is comprised of the vast majority of the world’s nation-states and shows no signs of collapsing any time soon. Although the WTO represents the culmination of multilateral trade agreements, other major regional agreements, such as the Trans Pacific Partnership (TPP), which was signed in 2015, appear to be the wave of the future. As emerging nations gain more economic power their leaders will continue to enter into multilateral trade agreements that they believe will be to the benefit of their nations. The growing power that developing nations have demonstrated in multilateral trade is reflected in those same nations’ desire to adopt monetary policies that they see as more equitable and beneficial to their interests.

Since World War II, the monetary policies of most nations has been influenced and in some cases, dominated by the United States. After the quasi gold standard of the Bretton Woods regime was abandoned, the world’s economies essentially switched to the U.S. dollar standard, which is to say that the dollar began to be used as the world’s reserve currency and de facto exchange standard. This development gave the United States immense economic power as the currency was no longer backed by gold, excess money could be printed, which would mitigate problems caused by the flow of capital from the country. It was in the realm of exchange rates though where the American dominance of the post-Bretton Woods international monetary order came to be most apparent and also one of the key areas where the emerging nations have diverged from the U.S.

The hallmark of the Bretton Woods era was the use of a fixed exchange rate, often referred to by economists as a “peg.” Fixed currencies worked well under the Bretton Woods system because although the U.S. dollar was the standard monetary value used, the rates were ultimately fixed to the price of gold, which prevented factors that could destabilize an economy such as currency speculation. After the collapse of the Bretton Woods regime, most countries, especially emerging economies, moved towards floating exchange rates. Many countries began to focus their economic resources on domestic objectives and viewed fixed exchange rates as a monetary albatross around their necks and another example of undue American influence that they wished to eliminate.

By the 1990s American deficits began to adversely affect many developing nations by creating inflationary cycles. Economic theory at the time held that by using a fixed exchange rate, a nation that suffered a particularly severe inflationary cycle could escape its morass and enter into economic prosperity. In a closed economic system this theory might work, but in the real world competitive imbalances combined with large capital flows combined to create economic chaos in many nations that adopted fixed exchange rates including the following: Mexico in 1994; several Asian nations in 1997; and Argentina in 2001. Because of the debacles that the above nations experienced with fixed exchange rates during the 1990s, the idea of floating exchange rates became more attractive in developing nations. Besides the reasons already stated above, the leaders of developing nations saw floating exchange rate regimes as a good way to strengthen their own economies; by allowing their currencies to appreciate in the world market rather than accumulating unwanted dollars, they have been able to strengthen the value of their own currencies and break the hold of the dollar to a certain degree. The move towards floating exchange rates is just one way that the developing nations of the world have challenged U.S. economic hegemony in recent years; the last ten years have witnessed a number of nations effectively organize to challenge the existing economic order as move towards a potentially new international monetary system.

Challenges to American Economic Hegemony

American economic power has been challenged in recent years from a number of different places, not the least of which has come from long standing allies in Western Europe. After World War II and during the Cold War, the United States invested billions of dollars into the rebuilding and protection of Western Europe, first under the Marshall Plan and then with the installation of numerous North Atlantic Treaty Organization (NATO) military bases. Most economists and historians argue that the investments paid off as the Western countries were able to reestablish productive economies and the westward spread of communism was stalled. Each of the nations of Western Europe pursued their own political and economic agendas apart from the U.S. and each other, but eventually moved towards political consolidation in the form of the European Union (EU) and economic homogeneity with the establishment of the euro currency in 1999.

The process that brought about the euro was agreed to voluntarily by the members of the EU, which has resulted in a relatively stable economy and currency. It should be pointed out though that not all EU member states use the euro currency: countries with inflation targeting monetary regimes and flexible exchange rates – such as the United Kingdom and the Scandinavian states – have opted to stay outside the EU monetary system for the time being. The EU definitely poses a challenge to American economic hegemony, but its challenge is for the most part indirect and lacks hostility. The United States shares many cultural attributes with its EU cousins and is also a Western nation-state so the possibility of a trade and/or currency war between the two economic blocs remains remote. A more direct challenge to American economic hegemony may come from a coalition of developing nation-states from around the world.

As mentioned above, since the end of the Cold War many developing nations have moved away from U.S. dominated monetary and economic policies and have instead looked to leaders from their own countries to develop policies that they believe better suit their interests. Alone, due to a still comparably much lower GDP and GNP compared to the U.S. and EU, these nation-states do not wield much economic power, but they have learned that cooperation among themselves has proved to be powerful. Beginning in the 1990s, the largest economies of the developing world began to cooperate unofficially to create trade agreements and to collectively advocate for a more managed international monetary system. The countries at the forefront of the new economic movement – Brazil, Russia, India, China, and South Africa, often referred to by the acronym BRICS – exerted enough political and economic clout to force the Group of Eight to expand its membership to twenty in 1999. The BRICS were officially established as an organization in 2009 when the member states held a summit in Yekaterinburg, Russia and since that time the coalition has been quite active in its attempts to influence the next international monetary system.

Since the BRICS nations are considerably less developed than the U.S., EU, and Japan, their economic objectives are quite different and sometimes diverse within the membership of the group. The BRICS for the most part favor floating exchange rates and have expressed desires to move away from the dollar as the world’s reserve currency. A large part of this attitude stems from China’s holdings of over $2 trillion in official foreign exchange reserves; if the dollar continues to lose value then so will China’s holdings, which has led it and the other BRICS nations to suggest moving towards a new world currency, specifically a system known as Special Drawing Rights (SDRs). The background and future of SDRs will be discussed more in-depth in part II, but for now the BRICS growing economic power is considered. The BRICS nations are also underdeveloped in terms of infrastructure so a large part of their economic objectives involves energy production and consumption.

Currently, in many Western nations, a large part of geo-political discussions have centered on the idea of climate change: is it occurring, if it is occurring is it man made, and if it is manmade what can be done about it? These questions are the source of controversy because they have taken an increasingly political tone over the last decade with those on the left arguing that the climate change is an existential threat that requires immediate attention, while those on the right believe the verdict is still out and that the potential threat of climate change/global warming is often used as a political weapon. Most of the developing nations of the world have attached themselves to the climate change camp as much for political and economic reasons it seems as any authentic belief that human activity is having an affect on the climate. In 2002 at the United Nations Climate Change Conference in New Delhi, India, fifty five nations ratified the Kyoto Protocol, which sets limits on the amount of carbon emissions that signatory nations are allowed to discharge into the atmosphere. This agreement greatly benefits developing nations, such as the BRICS, because with less production of fossil fuels such as coal, which is where most carbon emissions are derived, the cost of those fuels will precipitously decrease. With lower fossil fuel costs, large, developing nations such as India and China can purchase more in order to fuel their ever growing manufacturing plants, which will further give the BRICS another economic advantage over the U.S. and EU, whose manufacturing bases are quite small compared to China and India. Eventually, as signatories of the Kyoto Protocol, India and China will have to reduce their carbon emissions, but that is in the distant future and for the present and near future the move to reduce carbon emissions worldwide only serves to help the BRICS economically.

Special Drawing Rights (SDRs) and the Next International Monetary Regime

If the world adopts another international monetary regime over the coming decades it appears that the concept of SDRs will play a significant role. SDRs, which are favored by the BRICS and other developing countries, are not a new idea but have been gaining momentum as the developing world continues to assert itself economically. The concept of SDRs was first articulated by British economist John Maynard Keynes in 1944 as a way for nations with deficits to have access to credit provided by the surplus states. The original idea was blocked by the United States as it was seen as a threat to power of the dollar as reserve currency, but the idea was revived once more near the end of the Bretton Woods Regime.

Keynes’ concept was modified and implemented in 1969 under the auspices of the International Monetary Fund (IMF) as a way to facilitate international monetary transactions in a more equitable manner. In theory, SDRs were viewed as credits that were to be used to supplement and eventually replace the dollar as a reserve currency, act as a substitution for gold in IMF loans, and to be used as a unit of accounting for international transactions. Like with many things, theory and practice were two different things as SDRs have not yet fully replaced the dollar as a reserve currency and the use of gold in international transactions was eliminated when the Bretton Woods Regime collapsed; but SDRs have found a niche in international finance and monetary policy and are growing in popularity among developing nations.

Today, the use of SDRs has evolved and can best be described as a special purpose money created by the IMF that can only be used for repaying debts to the IMF. The value of SDRs that a country holds is calculated according to a “basket” of foreign currencies; in other words, the number of SDRs that a country holds equals the amount of foreign currency it has available to “draw” from the IMF. SDRs have elements of both credit and money: in terms of credit SDRs, as stated above, are used to pay back loans to the IMF, while the monetary aspect of SDRs is related to the fact that it is wholly fiduciary – SDRs operate under the trust and confidence in what they represent. Currently, the IMF mitigates the importance of SDRs, but developing nations and some of the world’s leading industrialists and economists advocate their use, especially after the worldwide economic recession of 2007.

Controversial billionaire George Soros supports the use of SDRs by industrialized nations for “public goods projects” in developing nations in a process that will eventually replace the dollar as the world’s reserve currency. Many economists who do not necessarily share some of Soros’ more controversial political ideas agree that SDRs may prove to be a viable form of international currency in the future because they represent stability in an increasingly unstable world. Increases in liquidity and uncontrolled capital flows throughout the world have the potential to create economic uncertainty, which, as a number of economists argue, can eventually lead to nations pursuing policies of protectionism and neo-mercantilism. Many of these same economists also point out that exchange rate fluctuations encourage rampant currency speculation, which in turn can lead to further economic destabilization. Advocates of the use of SDRs argue that such problems will be either eliminated or severely mitigated under an economic regime that relies on SDRs.

Is a Future International Economic System Viable?

An examination of current the current global economic scene reveals that the days of American economic hegemony appear to be over, but the jury is out concerning whether a new global economic regime can or even should be initiated. Most economists agree that it will probably still be decades before SDRs, some new type of modified gold standard, or another currency replaces the dollar as the world’s reserve currency. The dollar is the core of the current economic system – or as some economists refer to it, “the non-system, system” – and any attempts to quickly replace it would result in economic instability and possibly catastrophe. For the time being, nations will choose stability and the move to replace the dollar will be gradual, but eventually move towards a multi-currency reserve with a greater role for SDRs. As the world moves away from American economic hegemony and towards a new possible global system, there are also a number of problems to consider that may hamper efforts towards economic consolidation.

The future of the EU remains in question, politically and economically. The citizens of the wealthier EU countries, such as Germany and Belgium, are growing more and more perturbed over bailouts for the less wealthy member nations like Greece and Spain. The aging European population combined with a recent influx of migrants from the Middle East will put further economic strains on the member nations as the tax base continues to erode while the number of benefit recipients increases. There have also been political cracks in the unity of the EU recently as some governments – most notably Hungary, which built a fence along its southern border – have been lukewarm to hostile towards the idea of accepting possibly millions of migrants into their borders. The EU is also a dependent on oil from Russia, which weakens its economic position vis a vis the BRICS. The EU’s energy dependence could have many ramifications for the bloc: it may move closer to the BRICS in advocating greater use of SDRs, or it may be another factor that leads to the ultimate demise of the EU. The BRICS on the other hand have their own share of issues to overcome before they take the lead in installing a new economic world order.

The BRICS is currently a powerful economic coalition and one that will appear to exert its influence in the years to come, but it is not without some serious weaknesses that will keep it from creating a new international economic regime. To begin with, the nations of the BRICS are not a unified cultural bloc and some of its members have historically been enemies. Russia and China have been rivals for decades and nearly went to war in the past over border disputes. China and India have also been at odds in the past and as the BRICS is a much less politically and culturally unified bloc than the EU, its member nations can and will pursue policies that it views as beneficial to its own people, which may be to the detriment of other members. For instance, China appears to be promoting regionalism as it encourages the use of its currency, the renminbi, in Hong Kong. The use of the renminbi in Hong Kong may just be an experiment for its expansion in the region, which may threaten India economically. Finally, even though the BRICs nations may all be on board in supporting the increased use of SDRs, the quasi currency also has problems and is not the answer to all of the problems inherent in an international monetary system.

The extensive use of SDRs in a future international monetary regime ignores some of the core problems with the current system, or non-system. SDRs do little to address private foreign exchange markets and unrestricted capital flows, which can both contribute to international economic stability. Perhaps the biggest issue that many people have with moving to SDRs and what makes Soros so controversial, is that the transition will come at the expense of wealthier nations. If a new international monetary system is initiated that uses SDRs exclusively, then the value of the dollar, euro, pound, and yen will be diminished to the point that they will only be useful for domestic transactions, which in a global monetary sense can only help the nations whose currencies are not currently used in the “basket” of IMF currencies. Ultimately, in order to participate in such a monetary regime the U.S. will have to forfeit a certain amount of its economic sovereignty and possibly even political sovereignty, which would be a most odious situation to many Americans.

The evidence clearly shows that the next international monetary regime is far in the future if it comes at all. As economists debate the nuances of a future regime, most fail to ask if it is even worth the effort or why economic globalization is virtuous in itself. As mentioned above, the wealthier nations, such as the U.S., will have to sacrifice a fair share of their own wealth to take part in such a system, which is not an attractive proposition for most Americans. With that said, the trends seem to be towards greater global economic cooperation and even consolidation, but at a slow pace where the leaders of the wealthier nations can more easily “sell” the process to their citizens.