As France takes the helm of the Group of Twenty industrialized and developing economies, leading French statesman and former IMF chief Michel Camdessus has called for a radical overhaul of the global monetary system that would include ditching the dollar as the leading international reserve currency.
In an exclusive interview with Emerging Markets, Camdessus, a former governor of the Bank of France, said failure to place sweeping reform front and centre of France’s year-long G20 presidency would raise risks “as never before” for the global economy.
His comments came as French finance minister Christine Lagarde warned on Tuesday that the G20 must act fast to combat uncertainty over currencies.
“The G20 cannot deal with the current level of uncertainty on currencies, that is clear,” she said in London.
The failure of last week’s G20 summit to broker an agreement on currency and trade imbalances has brought the world economy closer to the brink of all out protectionism, while raising grave doubts about the ability of major powers to cooperate.
“The demon of protectionism has started to resurface,” said Camdessus. “The present system involves practices which are detrimental and unsustainable, including the accumulation of foreign exchange reserves and widespread moves towards pushing currencies down.”
He threw his weight behind France’s bid to reorder the international system under its year-long presidency of the economic group, while calling for a root and branch overhaul of the international system which has prevailed since World War II.
France’s president Nicolas Sarkozy has said that under his country’s watch, the G20 will seek a bold agenda which will include reform of the global monetary system to bolster emerging economies and to diversify international reserves, while improving global economic governance.
“Clearly decisive action is needed,” Camdessus said.
He added that the fragile global economy and financial markets could not withstand any further big shocks. “Imagine that a geopolitical situation now appears – this could present a dangerous situation which could even imply the collapse of the system itself,” he warned.
The statesman, who has informally advised both IMF managing director Dominique Strauss Kahn and French president Nicolas Sarkozy, said there was “no doubt” that France’s leadership “has understood” the importance of such a reform.
“[President Sarkozy] and many of his colleagues see that something very strong and credible must be achieved,” Camdessus said. “If not, we are in very dangerous waters.”
Reform of the international system should be based on “three pillars,” he said: enhanced multilateral surveillance, the proper management of liquidity provision and improved governance of the IMF, the “central institution.”
Camdessus called for “deep changes” in IMF economic surveillance of countries to make it “equally strong on all players.”
The IMF’s Mutual Assessment Process, or MAP – through which the G20 has sought a country-by-country roadmap for the global economy – is a step in the right direction but falls short as it lacks sanctions and incentives for countries to alter their economic behaviour, Camdessus said.
“[The MAP] is not a trivial effort, but to be credible [nations] should agree on a system strengthened by sticks and carrots,” he said.
The IMF and WTO already have in their founding treaties “sanctions for those who don’t play ball” on their commitments “not to play with their exchange rates for the sake of exports.”
Such sanctions can and should be used alongside incentives, including allowing countries “automatic and conditional” access to IMF precautionary credit lines.
The interplay between financial and monetary developments in today’s globalized economy means that “the idea of a Chinese wall between current and capital accounts is a prehistoric idea.”
The IMF’s powers should be boosted to create an institution that is “equally active and competent and mandated to act both in the financial and monetary field,” Camdessus said. “You cannot deal with one part of the balance of payments and not with the other. So the question of extending the IMF’s mandate is a must.”
The IMF’s role as lender of last resort must be radically up-scaled to allow it to respond to emergencies in a way that is not “totally disorganised and almost illegal,” Camdessus said.
The former IMF managing director also called for steps towards the creation of a substitution account at the Fund, through which unwanted dollars from surplus nations could be converted into special drawing rights (SDRs). “This would be attractive, particularly for the Chinese, but also for the surplus countries.”
While such a scheme – or “clearing house” – would not immediately imply a substitution account, it would “help the diversification of dollars in a framework of an economic policy which is seen as reasonable by IMF surveillance,” he said.
A mechanism of this kind would also reduce the risk involved in hoarding vast quantities of dollars. The People’s Bank of China this month reported a record $100 billion jump in its foreign-exchange reserves to $2.65 trillion for September, but the decision by the US Federal Reserve to pump money into the world’s biggest economy has raised fears in Beijing about the impact of the policy on the value of its war chest.
Camdessus called into question the central role of the dollar in today’s economy, pointing out the destabilising effect of US monetary policy on the rest of the world.
“We need also to respond to the need to rationalise the creation of international liquidity,” he said. “What was seen as the questionable privilege of the dollar in the 1960s is now seen certainly by almost all emerging countries in particular as a major problem as it destabilises capital flows.
“In the present world it is no longer possible to have the creation of liquidity for the entire world totally dependent on the domestic needs of a single country.”
He also urged greater use of China’s yuan as a reserve currency in the future, suggesting it should be included in the basket of currencies which underpins the IMF’s SDRs.
While he defended the US Federal Reserve’s resort to another round of quantitative easing, saying the central bank had little choice, he noted the move nevertheless underscored the need for a fundamental reform of the international system.
“The fact that the US is in such a corner that it has no other alternatives but to go in that direction – they know themselves that that’s very dangerous – shows clearly that we are in a situation where action must be taken to strengthen the overall system.”
“We need to decouple the provision of international reserves and liquidity from the evolution of US domestic needs,” he said.
He said that US Treasury Secretary Timothy Geithner’s proposal that limits be set on national trade surpluses and deficits was broadly right in its thrust. But he added that “Geithner was a possibly a little bit too precipitous in saying [trade balances should be limited to plus/minus] 4%. But the orientation is something which shouldn’t be rejected.”
Lagarde has said that the proposal is one of several that will be considered during France’s G20 presidency.
Camdessus welcomed the agreement reached in Seoul to boost emerging economies’ share of IMF voting power. But he said that “we won’t do a good job [in reforming the system] unless we recognize that the multilateral spirit has failed. Real global ownership implies a sense of responsibility. This was the spirit of Bretton Woods – and it requires a new principles-based multilateral system.
“If the system is not renovated at its roots, all other debates will be endangered.”