The Global Monetary System

A monetary system is the group of institutions through which a government delivers cash in a nation’s economy. Current monetary systems consist of mints, central banks, and commercial banks.

International trade for a long period has been impacted by a critical issue: the greater confidence nations develop around exchange rates, the less option they have to regulate the local economic activities.

Often, monetary systems have been the product of circumstances instead of design.

According to JM Keynes, the dominance of London in the global financial system was so significant in the late 19th century; The Bank of England was looked upon as the leader of the global financial system.

At present, the US is the dominant player. According to some experts, the global monetary system is the foundation for America’s global influence.

The global monetary system has been volatile for a long time. The gold standard of the 19th century crumbled due to the depression in the 1930s.

The Bretton Woods System of fixed exchange rates after the war collapsed in the 1970s. It was followed by a combination of floating currencies and mobile capital.

Currently, there is the need to resolve the trade deficits between nations without affecting the global economy.

If a nation with a trade deficit is asked to contribute significantly to resolve the imbalance by reducing imports, the global output would be less. Devaluation of the currency by a nation to bolster exports could result in other nations following suit.

The total gross capital flows are struggling globally. A nation with a current-account surplus/deficit has to invest overseas/secure net funds.

Economists in the 19th and 20th centuries felt the gross capital flows transitioning across the globe would represent the quantities. However, after financial globalization, capital flows are bigger in comparison to current-account imbalances.

The financial crisis in 2007-2008 and the following low-interest rates have led to speculation in the capital markets with an influx of capital into emerging economies.

The dollar’s position as the world’s reserve currency is supreme in comparison to other international currencies. According to experts, the dollar region covers nearly 60% of the global community (the US, nations with currencies floating with the dollar, nations with dollar pegs) along with 60% of the GDP.

The Fed develops the policy to support the US interest. A lot of offshore dollar deposits and securities can be found away from the US. Dollar payments, transit through the financial institutions that either directly/indirectly have a business relationship with New York.

A nation’s trade flows and related debts are in dollars, hence, the demand for the dollar. The dollar can be borrowed by foreign nationals from the US government. Several nations have established the huge amount of dollar stock by way of Treasury bonds.

The movement of the global capital flows is controlled by the US. Nations with currency pegs must imitate Fed policy or deal with the consequence of capital inflows (high rate) or capital outflows (low rate).

International banks are funded by dollars and grow/shrink in line with the economic environment in the US. Organizations having dollar debts/deposits don’t have any influence on the movement of interest costs/income. Mega international investment funds, based in the US, mostly secure funds in dollars.

Every nation in the dollar system is affected one way or the other. The three issues - imbalances, capital flows, and dollar dependence have created havoc. The problem is based on an economic concept - trilemma.

A nation can have only two of the three: a stable exchange rate, access to global capital flows and the freedom to control its interest rates.

Several nations followed a fixed rate system and were willing to receive funds from global sources before the financial crisis in 1997-98. They did not have a sovereign monetary policy.

The notion of security as a result of the pegs resulted in an accumulation of dollar-denominated debts in emerging economies. The pegs were delinked as the capital inflows fell. The value of currencies fell, which increased the cost of dollar debts. This led to a severe recession.

The aftermath of the Asian crisis led to currencies adopting a floating exchange rate system. At present, across emerging economies, the median net foreign-currency debt (total debt less reserves) has reduced.

China followed a different approach - pegging its currency to the dollar at a lesser rate. It resulted in huge current-account surpluses which were added to the increasing stockpile of American Treasury bonds.

However, the floating exchange system has its own share of issues - Speculation.

The global monetary system is not structured, not safe, and not viable in the long run. It needs to be restructured to control capital flows efficiently.

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