This report examines how the international monetary system (IMS) might evolve and the implications of different scenarios for the euro area over the next fifteen years.
After the collapse of the Bretton Woods system forty years ago, the IMS gradually developed into its present state, a hybrid mix of exchange-rate flexibility, capital mobility and monetary independence. The US dollar retains a dominant, but not exclusive, role and the IMS governance system blends regional and multilateral surveillance. It combines IMF-based and ad-hoc liquidity provision. Although it has proved resilient during the crisis, partly thanks to ad-hoc arrangements, the IMS has serious flaws, which are likely to be magnified by the rapid transformation of the global economy and the increasing economic power of emerging economies.
This report begins by taking stock of two major historical lessons:
• Since the beginning of the twentieth century, the emphasis in most countries has shifted towards internal rather than external stability. This priority is likely to remain pivotal in the coming decades.
• Although the dollar has been dominant for several decades, having succeeded sterling, history demonstrates that multipolar systems based on more than one key currency can exist, and can also persist for several decades.
This report assesses the implications for the IMS of the ongoing shift in the world balance of economic power. By 2020-2030 economic power is likely to be more evenly distributed among key players – the US, the euro area and China – than at any point in time in recent history. This report discusses what factors enable a currency to play an international role, and concludes that neither the euro nor the renminbi are likely to be in a position to challenge the supremacy of the dollar. However, they are likely to come to play a meaningful international role, provided certain conditions are met.
The report then outlines three possible scenarios for the IMS:
• A repair-and-improve scenario in which changes to current arrangements are introduced through incremental reforms.
• A multipolar scenario in which a system structured around two or three international currencies emerges.
• A multilateral scenario in which participants agree to take steps towards a
strengthened international monetary order.
The first scenario is the least demanding in terms of both domestic policies and international coordination and the most likely to prevail in the short term, while the third is the most demanding and therefore the least likely of the three scenarios. Though limited in ambition, the first scenario would be an important stepping-stone towards further development of the IMS. The second scenario relies on market forces and domestic policies rather than on international cooperation and the probability of it emerging, although fairly low in the short run, becomes higher within a 10-15 year horizon. The probability of the third scenario emerging is low, but can gain likelihood in case of major international financial crises.
Assessment of the three scenarios on the basis of efficiency, stability and equity suggests that:
• All three would offer improvements compared to the current system.
• Their feasibility negatively correlates to their desirability.
• The multipolar scenario would best correspond to structural changes in the world economy and mitigate some (though not all) of the flaws of the current IMS.
The deeper transformation of the IMS is likely to take a long time. The report analyses three specific issues for the transition and concludes that:
• The renminbi can attain a moderate international role without major changes to Chinese policies, but deeper reforms will be needed to rival the euro and the dollar.
• In the absence of a major overhaul of the IMS, the ‘repair-and-improve‘ scenario (which includes lower incentives to accumulate reserves), together with significant domestic policy shifts, can be powerful in reducing global imbalances.
• Concerning exchange-rate misalignments and asymmetries in the run-up to the multipolar and multilateral scenarios, (i) Chinese developments are not neutral for the euro/dollar exchange rate if China keeps a fixed exchange rate to the dollar, (ii) moving from a dollar-centred to a multi-currency system and more flexibility of the renminbi exchange rate could create more short-term exchange-rate volatility, but reduce the potential for medium-term exchange-rate misalignments, (iii) the internationalisation of the renminbi would be stabilising for the euro/dollar exchange rate.
From the point of view of the euro area:
• The multilateral scenario not only stands out as the most desirable, but is also particularly congruent with the euro area’s intrinsic principles.
• The multipolar scenario would be preferable to the repair-and-improve scenario.
• In comparison to the current dollar-dominated system, the euro area could benefit from a move to a bipolar system around the dollar and the renminbi.
• The capacity of the euro to increase its international status requires major decisions by the euro area, such as further governance reform, the creation of a Eurobond market, and the streamlining of external representation.
• Issuing a fully-fledged international currency involves both privileges and duties; increasing the euro’s role is a political choice.