Increasing interests in dollarisation
An interesting reform proposal is full or official dollarisation which has been attracting increasing interests since the 1990s. Dollarisation means that the home currency is replaced by the US Dollar or any of the other major currencies like the euro or yen. Arguably, dollarisation is favourable to unstable economies where the home currency is too volatile. For instance, countries like Panama, British Virgin Islands or Ecuador are currently using the US Dollar as the official currency.
Calvo and Reinhart (2000) argued that many countries, mainly including developing market economies, opt for dollarisation since they have large debt levels denominated in US Dollar, a large proportion of foreign currency reserves are in US Dollars and with dollarisation, these countries can more easily access international credit markets. This is in line with Goldstein (2000) who argued that dollarisation might eventually be the best option to have a stable global financial architecture.
Conversely, Balino, Benett and Borensztein (1999) argued that dollarisation will cause a slowdown in the economy of the country since the latter would have to give up its policy making decision to the currency issuing authority. Recently there has been a lot of hype with regards to a new exchange rate system called Bretton Woods II. However, so far, no such system exists but some countries having their currencies fixed with the US Dollar or other major currencies have been referred as Bretton Woods II; for instance the Chinese yuan which is pegged to the US Dollar has been called the Bretton Woods II by Dooley, Folkerts-Landau and Garber (2003).
World leaders and international authorities are currently working on a new global financial architecture and many have proposed for a new Bretton Woods System to be designed. However, it is critical that such a system is made to adapt to the new world financial environment which is facing increasing risk of recurring financial crises and also ensure that the system does not have the same drawbacks as the original Bretton Woods system which collapsed in the early 1970s.
Debt workout mechanisms
To reform the global financial architecture, it is important that there is an orderly workout of international debt as this may be an important tool to decrease or avoid future financial crises. As it has been observed in the Asian Financial Crisis and the current financial crisis, the effects of a crisis quickly spread over the world thereby causing defaults on external liabilities of countries which have a direct impact on international financial stability (Senior and Westwood, 2001). One way to limit such problems is by the use of bailouts. However, bailouts pose a lot of problems among which the main one is moral hazard. Also there is a shift of liabilities to the debtor countries as it has been witnessed in the current financial crisis (Jeanne and Zettelmeyer, 2001). Hence bailouts might not be an ideal solution to manage a crisis and furthermore, it is getting increasingly difficult to raise the required funds. So this has led to the rethinking of international debt workout
Raffer (1990) argued that the reform should mainly focus on the implementation of new principles as a means of reforming the financial structure. His main principles are:
1) debtor countries are given a time out or ‘stop debt servicing period’ in repaying their debts in case they do not have sufficient funds at a particular point in time;
2) to provide support to countries in terms of working capital to carry out operations when necessary;
3) to increase flexibility with regards to assets and liabilities of the debtor such that equity conversion is allowed to take place and write off bad debt when needed.
To implement these principles, Raffer proposed that all member countries of the United Nations should ratify a new international treaty to bring into existence an International Bankruptcy Court. This institution would arguably be able to guarantee an orderly workout mechanism for international debt.
Another proposal to improve the debt workout mechanism is to have debt audits. The current financial crisis has been a result of irresponsible mortgage lending and in many cases, the debt repayment capacity of borrowers were not even assessed. The debt audits will enable governments and financial institutions to determine which debts are legal.
The debt audit should be carried out as a transparent process to ensure its effectiveness. There is an increasing trend towards the adoption of debt audits in many countries since its implementation in Ecuador. With debt audits, it is expected that lenders will act more responsibly in the future.
Reform of the IMF
The roles of the IMF should be reviewed to adapt to a new international financial environment which is being increasingly affected by effects of recurring financial crises. While there are hundreds of proposals on the roles of IMF, this paper will focus solely on a very important proposal, namely converting IMF into an international lender of last resort. Among the advocates of converting IMF into a lender of last resort, Fischer (1999) argued that individual countries cannot deal with financial crises on their own because the world is too integrated and the crises easily contaminate other countries with maximum adverse effects on small and developing economies.
Fischer (1999) therefore proposed that if the IMF is converted into a lender of last resort, countries will be able to have adequate economic support to deal with the financial crises. This will maintain financial stability in markets thereby ensuring a fair exchange rate system. This proposal is supported by Sachs (1999) who argues that a lender of last resort will play a valuable role in case of liquidity crises which might arise from volatile exchange rates and failure of capital account policies.
On the contrary, Corsetti, Guimaraes and Roubini (2005) and Niskanen (2002) among other authors have argued that if the IMF becomes an international lender of last resort, countries may become lenient on their risk management activities and policy making as the governments know that they will have the support of the IMF should they encounter economic problems that can have an impact on international markets and the world economy.
The new roles of IMF should also focus on the improvement of policy making with regards to surveillance and conditionality. Moreover the voting system of the IMF should be reviewed so that developing countries can have more decision making power Gerster (1993).
A single world currency?
The proposals put forward by academics and professionals have laid down the stepping stones for a new financial architecture but we have yet to reach a consensus on the implementation of these proposals. As reviewed in this paper, some proposals seem to be more feasible than others but in my opinion, the ideal way to reform the global financial architecture is to have a single world currency. The main advantages of having a single currency for all countries would be the mitigation of foreign exchange risk and information asymmetry which have been among the main causes of world financial crises during the past decades.
However, the creation of a new world currency would only be achievable with the political and economic support of all the highly developed and industrialised countries. As proposed by Zhou (2009), one of the best possible options to achieve a single international currency is through the introduction of target zones as an initial step. But the main problem that might be faced with a world currency is that there might be conflicts mainly among the developed countries on the powers related to the issuance and control of the world currency. Arguably, the World Financial Authority proposed by Eatwell and Taylor (1998) could be a world regulator which would also issue and control the world currency.
By Roshan Boodhoo,
Managing Director, Alliance Trust Co. (Mauritius).