|HONG KONG – There is a growing awareness that, in today’s globalized world,
financial markets are beyond the control of national policymakers. While a few
economies do have the scale to shape interconnected global markets, they face
serious constraints, political and economic. As a result, the global economy is stuck in
a pro-cyclical financial cycle, with few options for escape.
As Claudio Borio pointed out years ago, the global financial cycle is longer and larger
than real economic cycles, and is closely associated with the fluctuating value of the
dominant reserve currency, the US dollar. When the dollar is weak, capital flows from
the United States to other countries, where it spurs growth through increased credit.
Unfortunately for these countries, typically in the emerging world, the inflows also
spur inflation, asset bubbles, and currency appreciation. The result is growing
financial and geopolitical risk, which makes the US dollar more appealing for
investors. As capital flows back to the US, the dollar gains strength, while emerging
economies are left to face the consequences of bursting asset bubbles and currency
In a zero-interest-rate world, a strong dollar plays the same deflationary role in global
markets as the gold standard did during the 1930s. The US is thus the economy that
is best equipped to pull the world out of secular deflation. But that requires a
willingness to resolve the so-called Triffin dilemma – the conflict between long-term
international interests and short-term domestic interests that issuers of reserve
currencies confront – by running increasingly large current-account deficits that
enable the US to meet global demand for liquidity.
This seems unlikely not only for the US, but also for its reserve-issuing counterparts
in the rest of the advanced world. Stagnant economic growth and high debt burdens
in Europe and Japan have destroyed politicians’ will to raise taxes or borrow more to
create space for fiscal expansion. As a result, monetary policy throughout the
developed world has become severely overburdened.
From 2007 to 2014, the central banks of the four reserve-issuing economies (the US,
the eurozone, the United Kingdom, and Japan) expanded their balance sheets by
$7.2 trillion. While this increased the broad money supply by $9 trillion, private-sector
credit increased by only $1.8 trillion, revealing a serious flaw in the transmission of
unconventional monetary policy to the real economy.
In fact, although near-zero interest rates have reduced debt-service costs, the real
burden of debt has actually increased in recent years, owing to declining inflation. As
long as households and companies continue to focus on deleveraging, these
countries will continue to face balance-sheet recessions.
As for the developing world, China is the only candidate for issuing liquidity. But its
once-spectacular growth is decelerating, with no end to the slowdown in sight. This is
generating enough uncertainty to keep Chinese policymakers preoccupied with
The problem today is a lack of will, not a lack of opportunities, to do what it takes to
boost demand. In fact, investment in global public goods – namely, the infrastructure
needed to meet the needs of the developing world and to mitigate climate change –
could spur global reflation. An estimated $6 trillion in infrastructure investment will be
needed annually over the next 15 years just to address global warming. Moreover,
the G30 has estimated that an additional $7.1 trillion in annual investment by the nine
top economies – which account for 60% of world output – will be needed to sustain
moderate global growth.
With the US, the issuer of the world’s preeminent reserve currency, unwilling or
unable to provide the liquidity needed to close the infrastructure investment gap, a
new supplementary reserve currency should be instituted – one whose issuer does
not have to confront the Triffin dilemma. This leaves one option: the International
Monetary Fund’s Special Drawing Right.
Of course, the road to becoming a reserve currency is long, especially for the SDR,
which currently functions only as a reserve asset, with an issuance size ($285 billion)
that is small relative to global official reserves of $10.5 trillion (excluding gold). But an
incremental expansion of the SDR’s role in the new global financial architecture,
aimed at making the monetary-policy transmission mechanism more effective, can be
achieved without major disagreement. This is because, conceptually, an increase in
SDRs is equivalent to an increase in the global central bank balance sheet
Here’s how it would work. Central banks, in order to generate resources, would
expand their balance sheets by investing through the IMF in the form of increased
SDRs. Because SDRs function as equity, they can be invested as such in the World
Bank and other multilateral development banks, which can decide which global public
goods deserve the resources. The drawdown of SDR allocations can be fine-tuned to
avoid causing too much inflation.
Consider a scenario in which member central banks increase their SDR allocation in
the IMF by, say, $1 trillion. A five-times leverage would enable the IMF to increase
either lending to member countries or investments in infrastructure via multilateral
development banks by at least $5 trillion. Moreover, multilateral development banks
could leverage their equity by borrowing in capital markets. Depending on the quality
of the projects, in terms of governance and cash flows, they could subsequently be
sold back to investors as asset-backed securities to fund new projects.
In the past, the financial resources available for investment were constrained by
national savings. In recent years, however, unconventional monetary policy has
shown that liquidity and credit can be created against global savings, with relatively
little impact on inflation, provided there is excess capacity in production and
insufficient effective aggregate demand.
The IMF and the major central banks should take advantage of this newfound
knowledge, and provide equity and liquidity against long-term lending for
infrastructure investments. In this way, global public goods can be not only funded;
they can also propel global recovery.
A version of this article appeared in Project Syndicate, 25 April 2016