IMS Study: Non-Reformed & Reformed

While the subject has stayed relevant in previous years, the global recession of 2008 really pushed the question “should the International Monetary System (IMS) be reformed” to the forefront of discussion. The current system is not in immediate peril, but those critical of the current system have cited possible future turmoil as a reason to overhaul the system. Both sides, non-reform and reform, both have valid points that should be explored in depth.

The IMS consists of institutions and rules designed to shape the process of how international payments are conducted; more specifically, the IMS provides the framework for exchanging goods, services, and capital among countries.

Additionally, the IMS works towards sustaining conditions that promote global economic stability and is intended to facilitate toward orderly adjustments to unexpected economic shock.

When a country agrees to become a member of the International Monetary Fund (IMF) the country also agrees to commit to obligations, such as promoting a stable system of exchange rates and passing economic and financial polies that are consistent with the IMF objectives.

The IMF also maintains the stability of the IMS through surveillance (IMSreform.org – About the International Monetary System, 2014).

The global recession of 2008 has resurged the debate over IMS reform in part due to the IMS’s resilience on the U.S. dollar and the lack of a more secure international reserve currency. Global trade has been diminished by the current system, where countries are allowed with a wide discretion to choose their own foreign exchange rate arrangements and international reserve policies.

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Although the current system can boom at times, it also has a number of weaknesses, including no automatic mechanism for resolving financial imbalances, volatile capital flows where exchange rates can have negative effects on the economy, and unabated accumulation of reserves on an international level (IMSreform.org – About the International Monetary System, 2014).

A global imbalance is classified as a country having a large account deficit in certain countries, while maintaining surpluses with other countries. These imbalances present a difference in investment rates and savings, a difference in the capacity of respective financial sectors that intermediate between savers and borrowers, dependence upon the system and quality of policies, and bad choices of policies that work to impede adjustments (IMSreform.org – Global Imbalances, 2014).

Capital flows have become a dominating factor in international transactions for a large amount of countries, especially those with more advanced economies, but have also started catching on for more emerging markets. A greater amount of capital mobility can bestow a country with many benefits, such as: greater efficiency in the allocations of capital, an improvement upon risk sharing, and greater discipline within the making of policies. Unfortunately, capital flows in emerging markets have shown to be very volatile, cycling between busts and booms. Managing capital flows for these emerging markets is a key in maximizing their benefits, while minimizing the risk (IMSreform.org – Capital Flows, 2014).

The global recession of 2008 has shown the importance of holding an adequate amount of reserves in order to mitigate external shocks. While having a large amount of reserves has proven an adequate strategy in managing large capital flows during the financial crisis, it also highlights the IMS’s failure to correct imbalances, which adds to the problem because the limits of reserve assets may not always meet the needs of reserve accumulators (IMSreform.org – Global Reserve System, 2014).

The international financial system is put at risk when a country comes under financial hardship and cannot come through on its external obligations. Recently, in light of the global recession, the need to strengthen the safety nets on global finance have increased. In response, the IMF’s lending capabilities was tripled and the lending process received an overhaul that allowed it to tailor the terms of a loan based on a country’s strengths and circumstances (IMSreform.org – Global Financial Safety Nets, 2014).

Robert Zoellick, the President of the World Bank, proposed an idea of reform to the IMS, suggesting to restore gold into a central role in the IMS. Zoellick proposed that this system would need to involve major currencies, such as: the U.S. dollar, the euro, the renminbi, the and the pound. Gold, as suggested by Zoellick, would serve as an international reference point for market expectations in regards to inflation, deflation, and future values of currency. The gold standard has history that any new alternative would not have, and these new alternatives would have to be considered more experimental in nature than gold would be (Kadlec, 2010).

Gold would serve as a good alternative to displace the U.S. dollar, something that no other currency can claim, as the debt crisis in Europe acts to eliminate the Euro and political risks eliminate the renminbi; no other country has shown to be adept at providing a stable currency within their own domestic economy. Zoellick also proclaims that the floating exchange rates have failed to address global trade imbalances; since 1967, the U.S. dollar has been devalued in comparison to the yen by 75 percent and to the euro by 72 percent, all while net exports have gone from having a surplus in 1967, to nearly a 400 billion dollar deficit in 2009, just one year after the global recession (Kadlec, 2010).

The global recession of 2008 has further pushed the IMS towards a reform, due to perceived weaknesses in regards to: global imbalances, capital flows, the global reserve system, and global financial safety nets. Many of cited the IMS’s dependence on the U.S. dollar as a critical failure point and have suggested that a common reserve currency would need to be found. Such suggestions have included gold, due to its history and lack of competition from foreign currencies to displace the U.S. dollar, due to instability in domestic economies.