The new world monetary order and the need for an EU foreign monetary policy

Published on October 7, 2009

European Federalists

current reshuffle of world power relations. Even more worrying is the fact that in the current discussions on the programme that the European Commission should implement during the next 5 years not a single word is mentioned about this issue which, if excluded, on its own, can do away with all the EU’s efforts to get out of the crisis.

In any normal state the currency is one of the main tools of foreign policy, for devaluation can increase exports, for it can attract or repel investments or when used as reserve currency it can help finance national debt. Any remotely good school of economics teaches its students that the equilibrium of balance of payments is one of the most important tools for the stability of a country. The EU seems to have forgotten that even though it is not a state, having a common currency means that it needs to act as if it were one when it comes to using monetary policy with its relations with the world.

Indeed, most of the trade of the EU countries takes place within the EU which might give the false impression that the role of the euro as tool of foreign policy is not that important. Are we, Europeans, reading the historical moment we find ourselves in correctly?

The 20th century has seen the rise and consolidation of the US as the world superpower which has been interlinked with the establishment of the dollar as the world currency. The current economic crisis, with the US decline and the emergence of new world powers, is leading towards a multipolar world and this will result in a new world monetary order which will re-shape economics, internal policies and international relations for years to come. During the last decades the US has been exploiting the condition of the dollar as a reserve currency to run colossal deficits in its trade and current-accounts with which it has financed its economy and has managed to keep its status of the world superpower. This time it looks like the dollar domination is over and during next years most probably we will assist to the birth of a new monetary world order.

We are observing how the continuous depreciation of the dollar is having devastating effects in the reserves of most world countries which are held in this currency. Most importantly, countries such as China which have huge surpluses in their trade account with the US see the fate of their economies linked to the strength of a currency whose strength diminishes whilst being forced to buy US debt to avoid further devaluations of the dollar.

Paul Kennedy in his article published in the New York Times on 28 August rightly pointed out two facts which signal an important change: during the G20 meeting in London of April the IMF received an allocation of 250 billion $ in Special Drawing Rights (SDR) and two months later a meeting of the BRICs –Brazil, Russia, India and China - debated shifting currency holdings from the dollar to these IMF units of account in order to diversify risk.

The debate on the post-dollar era and with it the new world monetary system is something that is happening, even if the EU wants to ignore it. We are assisting to the most important change in world monetary policy since 1944 when in Bretton-Woods John Maynard Keynes proposed the creation of a “bancor”, a world currency unit based on the average price of 30 commodities, and the US opted for a monetary system based on the gold standard linked to the dollar which effectively turned the dollar into the world currency. Back then nobody could challenge the strength of the American currency, fair image of the then most powerful world economy. This is no longer the case and the emerging economies don’t want to see its efforts to develop go up in the air with the destruction of its reserves whilst continuing to finance the US economy.

The United States have a clear interest in keeping the status quo in the world monetary relations, since this allows them to get their economy financed by the rest of the world. The Chinese have an interest in changing the rules of the game but they are not against the dollar per se because they indeed have most of their reserves in this currency. However they do understand that if things go bad and the Americans start printing money to finance their way out for the crisis this will lead to inflation and subsequently to a depreciation of the dollar which will decrease the value of the chinese reserves and do away with their development effort of the last decade. A similar reasoning applies for other emerging economies such as India or Brazil.

Also the European Union is and will continue to be severely affected by this constant depreciation of the dollar, since the comparative strength of the Euro will render the European exports more expensive and hence move jobs and economic activity out of the EU. There is a lot at stake for the EU in this game and if we look at the current state of affairs and the discussions taking place between the European Commission and the European Parliament on next years programme, it seems that neither have a clear understanding of the stakes in the game.

What should the role of the EU be in this new monetary world order? There are some reasons why the EU should take the lead in proposing a new system:

First and foremost, because it is easier to push for an equitable, democratic and transparent system in a multipolar world than in a polarised world. History teaches us that the predominance of a currency tends to be proportional to the power of the country that issues it. The end of the US hegemony will bring with it the end of the dollar hegemony and the new multipolar world will bring with it a new distribution of power that will be reflected in the monetary strength. Now is the time when emerging economies can agree to a compromise, in 10 years it might be too late. It is strategically important to take advantage of the moment to work out a plan from which all can benefit in the years to come. China may join a world system today but it won’t do it once it is doped with the taste of power.

Secondly, as indicated above because the current status-quo damages the competitiveness of the EU and unless it is reversed it can seriously harm the recovery of the EU economy. If we add a strong exchange rate and political disunion in monetary policy to the lack of a coordinated recovery plan and the inability of the EU to properly finance itself we have the ingredients for a troublesome future.

Thirdly and finally because if the EU doesn’t take (or join) the initiative the world will move on without and the cost of hopping on the train once it has started moving will be higher than being in the vanguard. Clear signs that the train is moving is when in March this year Zhou Xiaochuan, head of the Chinese central bank, called for an overhaul of the global monetary system by replacing the dollar for a world unit composed of a basket of the most important currencies (SDR). As explained before the talks among the BRICs after the 250 billion $ in SDR given to the IMF to guarantee stability also show a tendency.

The EU, except some timid initiatives taken by the French presidency a year ago, did not react to these declarations and signs and instead we continue to behave like if we were in the 20th century.

At present the EU 27 holds most of the voting power in the IMF and if acting together it could even decide to move the siege of the organisation to Europe. This simple example shows the power that the EU still has, although not for long, in influencing world monetary policy. The EU‘s weight in the IMF is disproportionate to its economic and demographic size and it will be corrected soon.Why not taking advantage of the last moments “in power” to give the right steps to create a more representative, fair and above all stable and robust monetary system? Isn'’t it in our interest? The euro can not and should not be the new world currency; instead the European experience of monetary integration could be very useful for the setting up of a new world monetary system based on SDR. Why does Europe stay silent when the status quo is harming European interests?

The eurozone has delegated competence in monetary policy and the council can decide by qualified majority on a proposal from the European Commission: it is therefore in the hands of the European Executive to put together the EU monetary plan. Ideally, the newly elected president of the European Commission should seize initiative and put the European Union at the forefront of these crucial negociations for the world governance. The role of the euro in the new world monetary order should have a prominent place in the program that Barroso will present for approval in front of the European Parliament together with the new European Commission in December 2009 or January 2010.