Who will decide which nations can accumulate debt and which cannot?
There is a multi-currency framework emerging which will be structured predominantly around the US dollar and the Chinese renminbi. Both nations and their respective national currencies represent opposite extreme ends of the international monetary imbalance which has caused financial stress around the world.
One end you have the United States as the world’s largest debtor nation with the largest trade deficit. On the other you have China as the world’s largest creditor nation with the largest trade surplus. All other nations exist somewhere on the scale in-between these two positions.
The stress which is caused by the monetary and financial twisting which takes place between the two positions has caused serious international concern. The Asian currency crisis of 1997 and 1998 along with the financial crisis of 2007 and 2008 are both attributed to this imbalance.
This imbalance will continue to grow until the international accumulation of USD is slowed and reversed. The renminbi will have to be internationalized to a level where it can carry some of the reserve responsibilities along with the dollar. Both national currencies can serve as balancing mechanisms within the international monetary system.
Currently USD accumulation has slowed within China which is visible in the reduction in their foreign exchange reserves. Equally so RMB accumulation and internationalized has been increased incrementally, with much more to go before balance is achieved.
The normalization of monetary policy in the United States through Federal Reserve rate increases will continue to expand and broaden the pressure caused from the imbalance. The developing credit crisis in China is also contributing to some of the international challenges. We must keep in mind that the large expansion of credit was a response to the large amount of US debt which China was required to finance as a part of the USD reserve framework.
As dollar appreciation happens it causes depreciation pressure on the renminbi. China has been fighting this downward force for some time now and will eventually have to completely end the dollar peg it has maintained so the RMB can appreciate.
Shattering the USD exchange rate regime which has been at the core of the international monetary system for decades will lead to the complete restructuring of national currency valuations and force new trade agreement negotiations, as the existing ones were structured around the USD framework as opposed to a multi-currency framework.
A functional and sustainable re-balancing will require the USD to depreciate in order to promote exports, which will lower the trade deficit, while the RMB will need to appreciate in order to slow exports and lower the trade surplus.
To avoid the future imbalances which we call the Triffin Dilemma, neither the USD or the RMB can be used in a “lender of last resort” capacity. Under the dollar system the USD liquidity could be expanded in the event of financial crisis which only deepened the problem. Chinese monetary authorities are aware of this dilemma and will not want to repeat the mistakes which caused the US to go from the largest trade surplus at the end of World War Two to the largest trade deficit now.
This will require something other than either the dollar or renminbi which can serve as the denomination of lending in the event of future crisis. A framework supporting the Special Drawing Right (SDR) of the International Monetary System is being built with Chinese support and encouragement. American authorities are aware of the need for such a system but have not yet been outspoken about its support for such an SDR based framework.
Initially the multi-currency system will be foundationally based on the balance between the USD and RMB with the IMF acting as the lender of last resort. SDR liquidity can be expanded and loaned out on a quota basis. This would include the potential substitution of existing USD denominated foreign exchange reserves which can be exchanged for SDR.
SDR serving as a unit of account can also function as an alternative to the dollar based exchange rate arrangement. This will be the case in years to come but we may find that nations begin to peg to the SDR through a slow process of monetary transformation.
The process could also be faster in the event that there is a large financial and monetary crisis which would require fundamental action and change.
A continuation of the USD standard will only amplify the problems that currently exist. Replacing the USD standard with an RMB standard will also lead to imbalances. The SDR is somewhat immune to imbalances caused by the Triffin Dilemma.
All nations are ultimately debtor nations, whether to themselves, banks, or foreign central banks. Under such a system all nations could utilize a debt and quota instrument such as the SDR as the international monetary standard. Unless nations decide to move away from the debt creation model of money the SDR provides a viable path forward.
The SDR doesn’t address the issue of growing debt itself though. This will be the fundamental challenge under the new framework. Who will decide what nations are allowed to continue accumulating debt and which are not? This debate will consume future policy makers. – JC
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JC Collins can be contacted at email@example.com