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The Improbable Rewriting Of The International Monetary System

Nicolas Sarkozy's call for a "new Bretton Woods' is ripe. The only problem is how to make it happen.

yuan coinIvan Walsh

In 2008, at the height of the global financial crisis, French President Nicholas Sarkozy famously banged his fist on the table in a plea for the establishment of a new Bretton Woods international monetary system better suited to the world of today.

Last year, at the G20 in Seoul, emerging countries led by Brazil warned against the risk of a currency exchange war, accusing the United States of deliberately weakening the dollar. Suddenly, one of the French president's priorities for the G20, considered by many as yet another harebrained French idea to try to regulate everything, was suddenly on the table. All the G20 members concur: the international monetary organization should be revised.

It remains to be seen how to modernize a system revised in the early 1970s to tie the mechanism of floating currencies, backed by the dollar as the sole reserve currency. The system is anchored by the primary exchange reserves of international central banks, which for nearly 30 years, could respond to the needs of the global economy. But with the new major economic actors that have entered the picture come new currencies. The international monetary system is no longer the sum total of the seven most industrialized countries' currencies. Now the Chinese yuan, the Indian rupee, the Brazilian rial, even the Russian ruble and the South African rand, should be included.

There will be no repeat of Bretton Woods, when the monetary system was thoroughly redesigned in 1944 from top to bottom to make room for a whole new model. It is more gradual evolution today. No credible alternative exists to the greenback as a global currency. In order for a currency to have potential as a reserve, it should inspire confidence, based on strong political power. A financial market should also be sufficiently large for international central banks to be able to place their reserves in profitable assets (for the most part issued by the Treasury). Finally, and most importantly, the currency should be convertible. Today, only the dollar can claim these three elements.

Who could have what the dollar has?

The Chinese yuan is admittedly backed by strong political power. On the other hand, the Chinese financial market of government securities is not adequate in size. The yuan is not only inconvertible, but it is barely internationalized. As for the euro, the recent composition of exchange reserves reveals that if the dollar made up 60 percent of the reserves, the euro would only represent 25 percent. The euro's financial market is comparable to that of the United States and the money is indeed convertible. But Europe's political cacophony is a major handicap, and the recent sovereign debt crisis in countries like Greece and Ireland also weaken its position.

If no currency can claim to substitute the dollar, why not create one from all the pieces? Some are pushing for Special Drawing Rights (SDR) from the International Monetary Fund (IMF) to play this role, or at least to assign it more importance as a reserve currency. The idea is not a new one and was explored in the 1980s without success.

The SDR is not a currency in and of itself, but rather a countable unit calculated as a function of a basket of currencies (the dollar, euro, pound sterling, yen). It is also a reserve asset for central banks of member states held by the IMF, and calculated on the basis of capital held by each country.

Ousmène Mandeng, an investment adviser at Ashmore Investment Management and a former senior executive with the IMF notes that the SDR consists of no more than 4 percent of central banks' reserves, half of which is held by G7 countries. "Reinforcing the role of the SDR requires not only approval of 85 percent of the members of the IMF, but also a better distribution of the IMF's capital between the wealthy countries and developing ones," says Mandeng. "Suffice to say, the process will take years."

Adding to the creation of a new global reserve currency is a "very ambitious' project, unlikely in the short term. Rather, events seem to beg for the continued presence of the dollar, coupled with the existence of so-called secondary currencies to take into account the current multi-polar world. Nothing will be put in place in the coming months, a fact also recognized by Sarkozy.

"The French president should propose a gathering of financial specialists over the course of several months to discuss the development of a financial infrastructure adapted to this century," says Jean-Pierre Lehmann, professor at the International Institute for Management Development (IMD) in Lausanne, Switzerland. "What's been done so far is amateurish."

Lehmann cautions against hasty response, noting that "Bretton Woods took several months to lay out after the war." The risk is that a series of proposals will emerge, based on the divergent interests of each of the major players. A comprehensive rewriting of the system can only occur when there is a true sense of urgency: when a crisis arrives that is even more serious than the one we are facing.

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