KUWAIT — On paper, the international monetary system has to guarantee - with its institutions, policies and conventions - the orderly functioning of transnational financial flows and exchange-rate regimes. Over the past few years, however, most currencies' exchange rates fluctuated at an unprecedented pace, hampering commerce and capital transfers. At the macro level, to ensure capital flows, trade relations, and global prosperity, money needs to flow smoothly across countries. A few internationally-trusted currencies – the so-called “global reserve currencies” – need to facilitate the setting of prices, the payment of goods and services in global markets, the holdings by governments and institutions of foreign exchange reserves, the denomination of balance sheets for both public and private actors, and the accumulation of savings and (central) bank reserves. Since the onset of the 2008-crisis, however, periodic uncertainty about the global economy resulted in currency volatility. Search for safety privileged the US dollar, as policy intervention kept the Japanese yen and the Swiss franc from overvaluation. In the eurozone, capital flight created a quasi-currency market within the single currency area. The “German” euro became sought after, with 10-year Bunds yields below 1.4 percent. At the micro level, firms need to be able to count on stable cost structures, gradual exchange rate adjustments, predictable business outcomes and orderly rebalancing of external accounts. Instead, currency uncertainties created important managerial challenges over the past years. Firms – in particular small and medium enterprises exposed to currency movements by a disaggregated supply chain –suffered exchange rate volatility and its effects on costs and prices, especially when incapable of complex treasury operations (e.g. active hedging). What is happening? Why isn't the international monetary system delivering stability as before? Because it is going through a tectonic shift, unlikely to be frictionless. Currently, the international monetary system heavily depends on the US dollar and the euro. Together, the two “global reserve currencies” account for: a) about two-thirds of global foreign-exchange trading - these are deep and liquid markets, with an average daily turnover of about $4 trillion; b) nearly 90 percent of the foreign exchange reserves held by central banks and governments; c) almost 80 percent of the value of Special Drawing Rights, the reserve asset used in transactions between the International Monetary Fund (IMF) and its members; and d) more than three-quarters of all debt securities denominated in a foreign currency. Still, as economic interdependence among emerging markets intensifies and the correlation between their currencies grows, firms are increasingly driven to switch trade contracts from US dollar or euros to local currencies. Furthermore, analysts and investors are voicing concerns about the future stability of the US dollar and the euro and a weakening of their role as “store of value”. The economies of the US and the eurozone are fragile, face high debt and will undergo significant internal structural adjustments; these factors are likely to constraint their role as leading international currency areas. In other words, the global financial system is asking for more than one reserve currency, and a few monetary zones of regional significance. The world might drift towards a multiple reserve-currency system shared among the US dollar, the euro and - sometime in the future – the Chinese renminbi. No one currency is likely to take over. Over the next decade, the US dollar will not lose its reserve-currency status and will remain the major investment currency. In the short term, there is a lack of viable alternatives and the US dollar will remain a key “unit of account” and “medium of exchange”. Still, its centrality in the global monetary system will be gradually re-appraised. Indeed, a multi-polar currency system implies a slow, steady reduction in the long-term share of US dollar assets in central banks' vaults and private portfolios. The trend is there: the US dollar's share of global foreign-exchange reserves has already fallen from 80 percent in the mid-1970s to around 65 percent today. It is likely that the greenback will continue its downward trend against other major currencies and its position will slowly deteriorate. There are advantages: if other major currencies constitute greater portions of the world's foreign exchange reserves, the US might find increasingly easier to maintain its current account deficit at manageable levels. The euro will remain the primary alternative to the US dollar. True, the turmoil in Europe has caused a loss in confidence in the future of the Euro, and until a new governance and a fiscal union are built the shift from US dollar to euros will pause. But if the Euro survives - and it is likely to - the rebalancing in favor of euro of countries with large reserves now overweight in US dollar will resume, causing the value of the euro to rise again relative to the US dollar. The Chinese renminbi will incrementally be accepted in trade settlements and outbound investments. In turn, China needs to cooperate in global currency management, promote regional integration, and deepen its domestic bond markets. For China there are also clear benefits (not only the above mentioned costs): as the renminbi becomes global, the country will be able to enjoy the financial advantages of printing a reserve currency (seignorage, above all), domestic macro-economic autonomy, balance of payments flexibility (i.e., it will be able to run sustained current account deficits), low borrowing costs, and a financial markets hedge. Managing such a multi-polar global economy will present serious challenges. For the system to be redesigned, a coordinated adjustment at the global level is needed, with the G-8 to allow a change in the geopolitical monetary hierarchy. As the new financial architecture needs coordinated global answers, a reformed IMF should play a key role in helping distribute benefits, costs and responsibilities. Of course, national and regional politics can lead to sub-optimal global outcomes. Until this process is complete, expect uncertainty and volatility to stay. — The writer is CEO of Foresight Advisors, a management consulting firm that provides customized advisory services.
