The US dollar’s so-called overwhelming position of dominance in the global financial system poses risks to world financial stability, but it’s not clear that a more diversified arrangement would be any safer, the Bank for International Settlements said on Tuesday.
The global system’s biggest weakness is its inability to prevent the boom and bust build-up and unwinding of hugely damaging financial imbalances, said Claudio Borio, Head of the BIS Monetary and Economic Department, in a speech in Zurich, Reuters reported.
Having the US dollar as the sole, if sometimes shaky anchor, of the global system does little to directly address that problem, but neither would having multiple currencies on a more equal footing, Borio said.
The dollar’s pre-eminent position as global reserve currency, unit of trade, and conduit of financial liquidity can exacerbate the tendency to instability by allowing the United States to run larger and more persistent fiscal and current account deficits, and to run looser monetary policy for longer.
The inherent easing bias in the Federal Reserve’s monetary policy spreads to developed and emerging economies alike through policymakers’ resistance to stronger exchange rates perhaps for macroeconomic, financial stability or competitiveness reasons.
“As a result, easing begets easing. Thus, according to typical benchmarks, monetary policy has been exceptionally easy for exceptionally long at the global level,” Borio said.
Currency of Choice
The US dollar is involved in 87% of all foreign exchange transactions around the world, accounts for some 60% of official currency reserves, as well as debts and assets outside the United States, and is the currency of choice in nearly 60% of all international trade.
But while a more pluralistic system might impose greater discipline on the dominant country, the world financial system would still lack a solid, credible global anchor. It would do little to change the need for a greater focus on preventing financial imbalances from building.
Policymakers should instead look at implementing more robust domestic policies, tackling financial booms and busts through a combination of monetary, fiscal and prudential measures, the report said.
Governments should also focus on gross capital flows instead of net flows, for example, and refrain from recommending expansion in surplus countries that are showing signs of financial imbalances. This is what happened in Japan in the late 1980s, contributing to the subsequent crisis, Borio said.
More recently, China has undergone a massive credit-fueled expansion following the 2008 global crisis, “an expansion that lies at the heart of some of the debt challenges the country is now facing,” he said.
Borio also recommended domestic policies be set with more of an eye on the potential global spillover effects they may have, as well as fostering more regular and deeper international coordination.
“Cooperation could extend to occasional joint decisions, on both interest rates and foreign exchange intervention, beyond the well honed responses seen during crises.
