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Thecreation of the euro area developed a monetary bloc comparable with that of theUSA. China's growth also suggests that it has the potential to be equal withthe dollar area and the Euro area. So now we have to sit down and consider whatis the best kind of monetary system that will be suitable for an upcoming andemerging new system of different structures and political power configurations.We have an opportunity to make a new and better system to replace the currentone and the defunct ones of the past.
Reporter: LinShu（Professor of Economics, Fudan University）
Editor: RobertOrr, Che Rui
Reporter:What do you think of the currentinternational monetary system and what is your view about the future ofinternational monetary architecture?
RobertA. Mundell:Let me begin by mentioning the fact that 2014 is the 70thanniversary of the Bretton Woods conference in July 1944, when economists gottogether to work out a post war monetary system. Because of the setbacks in the1930s and the second breakdown of the gold standard, they needed to plan forthe future. Although this was during theWorldWarII, theymanaged to set up a postwar system which fixed the price of gold to the UnitedStates' dollar and other currencies. There were a few mistakes and the systemworked quite well for awhile, but it was eventually replaced with anew system using managed and flexible exchange rates.
Today, we are again in apositionwhere we don't havean international monetary system.The BrettonWoods system brokedown in 1971 when Nixon took the dollar off the gold standard so that thedollar was no longer convertible to gold. Other countries took their currenciesoff the dollar too. Shortly after that, they went back to a fixed exchange ratesystem based on the dollar in the Smithsonian institution in dc. This systemdidn't last long. The pure dollar standard was a pure exchange rate, but therewas no agreement on how or who was going to determine the inflation rate.Before, the amount of gold was able to determine all this, but the USA'smonetary policy would determine settlements, but there was little agreement onthis because the Europeans thought US monetary policy was too expansionary forEurope and they didn't want to appreciate their currencies in this way.
So in June 1973 it was decided to scrap theinternational monetary system and let fluctuating rates come into being. Therewas no agreement on it. Europeans wanted to get back to a fixed exchange ratesystem, and other small countries wanted to too. Eventually, there was anamendment to theInternationalMonetaryFund's Article ofAgreement, so now we have a new system of managed flexible exchange rates.
The creation of theeuroarea developed a monetary bloc comparable with that of the USA. China's growth also suggests that it has thepotential to be equal with the dollar area and the Euro area. So now we have tosit down and consider what is the best kind of monetary system that will besuitable for an upcoming and emerging new system of different structures andpolitical power configurations. We have an opportunity to make a new and bettersystem to replace the current one and the defunct ones of the past.
Reporter:Thepost 1970s system seemed to work quite well till recently. It is also quitestrange that the current problems are not related to the traditional dilemmas,but are more related to the recent financial crises. What are your thoughts onthis?
Robert A. Mundell:From amathematical perspective, the idea that every country in the IMF can use theirown flexible and managed exchange rates, their own monetary policies and theirown separate rates of inflation with no connection between them is completelyridiculous. There are 188 members of the IMF, 17 countries in the euro areahave only 1 currency, and that means about 171 countries in the world each haveseparate fluctuating exchange rates and independent prices. There's nopossibility of finding common prices, nor a cheapest market. There's thousands,millions, of cheap prices to cope with. It's been partially successful becausethe dollar has been serving as a global unit of account.
Despite this however, a series of systemiccrises have continued to impair the international monetary system over theyears. There was the oil crisis in the 1970s, and the international debt crisisin the 1980s, which was when Mexico and other Latin American countriesdefaulted. There was also the savings and loan crisis, the Asian crisis in the 1990s,and now the most recentinternationalfinancialcrisis.Each of thesewascaused by big changes in exchange rates. The one in the 1980s wascaused by a combination of the dollar going way down, and the Europeancurrencies soaring. The developing countries borrowed a lot when the dollar waslow, but then they had to pay back increasingly high prices that bankruptedthem and caused the crisis.
The Asian crisis was initially caused bythe RMB devaluation in 1994, but the depreciation of the yen from 1995-98 had alarger impact. The dollar went from less than 80 yen to 148 yen. This knockedthe strong dollar, which then knocked all those other currencies that wereinvolved in the Asian crisis. The crisis that came in 2008 followed thesubprime mortgage crisis and the big bailouts by central banks in August 2007.The crisis itself though was because of the dollar soaring again. It was thisflight into the dollar safe haven that has continued to knock weaker currenciesand produce huge swings in exchange rates.
To follow all this up, in 2011, the Frenchpresident of theG20, Sarkozy, made 3 critiques of the international monetary system.His first point was that there's been an excessive instability of raw materialprices;Secondly, there has been extreme instability with regards to exchange rates;Thirdly, there's been a lack of governance in the international monetarysystem because organizations like the IMF have very little power. Again, this isnowherenear a catastrophe, but it's still important to consider thesedeficiencies and look towards finding alternative ways to improve theinternational monetary system. My own predilection is that the single mostimportant problem is the instability in the exchange rates. If we can'tstabilize theDollar-Euro rate, then there can't be a global monetary system.Fluctuating rates of exchange rates is a nonsensical system.
Reporter: What's the most important factorto control excessive volatility? Some scholars have suggested adopting a worldcurrency and some suggest using other reserve currencies. What is your take onthese assumptions?
Robert A. Mundell:Creating a world currency is ideal if there is more than one. It'slike having a common language that is everyone's second language so that peoplecan all communicate with one another.
Finding a currency that is above the otherswhich every currency can convert into, is similar to what gold did in the past.Under the gold standard there weren't fixed exchange rates. They were fixed togold which determined exchange rates through free markets which kept exchangerates fixed within narrow limits.
The difficulty lies in creating asubstitute for gold. Gold won't work. It can be dug out of the ground is usedto various different reasons. It has too much intrinsic worth outside of itsmonetary value, and countries also don't want to risk sacrificing theirnation's sovereignty to make for an effective international monetary systemwithout a world government. Can we create one using the gold standard and nopaper currency? I fully support this but there wasn’t a plan for this at Bretonwoods. They had plans, like Keynes' plan put forth by the British, and White'splan by the US, for a world currency, but it never came tofruitionbecause it was not politically agreed upon to have that, and wasn't palpableenough by the US at that time in how it would work.
I also want to emphasize that the currentsystem hasn't been a complete failure and nor does it require a completeoverhaul. It's been working out great for nations like China. It hasaccumulated about 4 trillion dollars of reserves over this period. With a goldstandard, this would have led to new money being taken away from othercountries and created a crash. The ability of the Federal Reserve to continueprinting money has allowed it to behave much like a central bank and supporttheForeignDirectInvestments (FDI) in developing nations, like China. This has workedwonders for China and has allowed it to build up an establishment with a lot offoreign investment from abroad.
We don’t want to destroy our currentinternational monetary system. Some parts of it are great. Maybe it has gone onfor too long, but we want to keep some of it for the future system. It's beenpermissive. Although the arguments against a permissive system is that it mightbe inflationary, but this one hasn't. There's been no inflation in either theUSAor China. These are the 3 main parts of the world that we have toconsider. We have to get an international monetary system. We can't take awaywhat we have, but we can make improvements. The biggest improvement would bestabilizing the US-euro exchange rate. China fixes to the dollar, so it hasproblems when the US-euro exchange rate changes, because then the RMB has tochange to also match the euro. This is a big market now, and one that has to beconsidered. But can we have a world currency without a world government?
Reporter:Do you thinkSDR(SpecialDrawing Rights)has the potentiality to become aglobal currency?
Robert A. Mundell: In my opinion,SDR won't become a global currency because youcan't have currency out of a basket. It's like adding dollars, plus euro, plusyen, and soon the RMB too. Then you have the five currency basket. As long asthose rates are fluctuating, no one is going to use this currency as tool forbond pricing ratings. It would be fine if they were all fixed together, butthey are not. WhenSDR began, it wasn't rated as a currency basket. It was rated as one35thof an ounce of gold. It began as equal to the gold dollar in1968. Then the gold value the guarantee was stripped away in1974when the basket system was created.
There were a lot of advantages to havingthis basket, but it is not a currency or a good unit of account. It loses thisproperty. Now it is a useful instrument for giving away money to developingcountries. It is becoming an instrument of foreign aid. Developing countriesare fine and advocating that the FDR become an instrument for foreign aid. It'sgood on its own ground but this has nothing to do with the monetary system. Let’skeep theSDR and just acknowledge that it's not going to be money. It's goingto be a weighted average of soon to be 5 currencies that countries can use asforeign aid.
Reporter:Do you think the Euro area is an optimalcurrency area? Some believe that the level of effective mobility is too low forthe Euro area, especially with regards to labor mobility.
RobertA. Mundell:I don'tthink that is a fair critique. You don'thave migration inside countries nor a great deal of migration anyway. You don'thave Germans leaving Germany, nor people in depressed regions like the Balticemigrating either. You just don’t have people moving very much. People typicallylike to stay in the place where they are. There is a lot of mobility. TheGerman labor force has changed enormously and now there is a sizable Turkishlabor force. There is a high degree of a discrepancy between the margin of thekind of labor needed and the people to fulfill those roles. The problem isn'tthe lack of labor mobility. The problem is that the unemployed in places likeSpain and Greece aren’t the ones needed to go to Germany if there is laborsurplus.
This is even the case in the United States.The unemployment rate is 7.5 percent, maybe 2 million too much. Along with thegrowth of the labor force, there are people who are unemployed that areuneducated. They can't get the jobs that exist. In France I heard aninteresting figure. There are 3 million unemployed and 3 million vacancies.They don't mix because of the unmatchedskill characteristics. It's a type ofstructural unemployment. The problem in Europe is the same issue it had beforethe euro came in. In the 1970s, this type of unemployment was all over Europe.There was a big surge in government spending in the 1960s in Europe. I once dida study on this, the government's spending was on average about 25 percent ofGDP in the 1970s,80s, and90s. It has shifted up towards 50 percent, and not towards spendingon infrastructure, but in social welfare pensions and medical plans. Peoplewanted these and governments catered to them without much responsibility whenthey enacted these reforms.
But they couldn’t find the taxes to pay forall this spending and this ran up big budget deficits. Italy ran it up to 120percent of GDP when it went into the euro zone. Greece's was 110 percent ofGDP, and Belgium was about 130 percent. Even these understate the problembecausethe unfunded liabilities also have to be considered too. When you lookahead at major hits over the decades, governments have to spend using deficitin the budgets that haven’t been funded. The real debt is much higher than itactually is. These debt/overspending problems that individual nations have arenow just more spread out in a community like fashion.
Major countries like Greece did welfareprovisions that were equal to those in Germany, but its per-capita income wasmuch lower, around two and half times lower. So Greece went bankrupt and had tobe bailed out. Now Greece has to scale down, but the Greeks turned over theunemployed to the government and run the deficit up even more. Greece has hadmajor changes though. It had about 900,000 people out of a population of 10,000,000working for the government. That's almost 10 percent of the population. Theyhave brought it down to around 700,000. It's a lot but still not enough. Eitherway, it's a major adjustment. It highlights that people need to make plans sothat they don't get hurt. In some cases you have to work out the tax system,but if you raise taxes too much you will make work for an unproductive system.
One way of addressing this is by having amore expansive monetary policy. Many people think this and so does the head ofthe European Central Bank, Mario Draghi. However there is amandate that the European Central Bank has that says it's not supposed to doanything that will raise the inflation rate. Nobody wants it. But there's alsoanother mandate that says Draghi has to save the Euro, so he's going to doeverything he can to save it. One way of fixing this is to not let the exchangerate of the euro go to high. This happened last year, and it was a mistake bythe banks.
Either nations behave more responsibly withtheir deficits, or else there's going to have to be a stronger fiscal centralauthority which these nations are subject to. Nations need to stabilize theirincreases in spending if they want to come out of their respective mires.Germany has to be more willing to lend more and help stabilize other nations.But having a monetary union like this is a touchy argument. 9 nations havealready gone bankrupt, but not because of a lack of a fiscal union. This isbecause of state spending. A minister of finance could stabilize the increasein spending and also make cuts, but it requires a big shift of power.
Reporter:Chineseis taking concrete steps to change its financial system. Initially, China useda fixed exchange rate system to control the inflation, but now China is runninga large currency account surplus. What do you think of a revaluation of theRMB?
RobertA. Mundell:Manypeople are recommending a lowering of the price of the dollar. When the dollarwas pegged at 8.28 from 1997-2005, Americans insisted that it should be loweredit to 4 or 3 RMB to the dollar. This would have instigated larger unemploymentrates and wrecked China's growth. In 2008, China was hit hard by theeurocrisisbecause that's when the dollar was soaring against the Euro while the RMB wasappreciating against the dollar. So that's why China fixed its currency rate at6.8 against the dollar and also why it has only let its appreciation go downvery slowly. It's a strategy that has been working very well. The only timethat China should think of appreciating its currency is if keeping it fixedwill create excessive inflation in China.
Reporter: China has very strong capital control of thefinancial market. Do you think China should loosen up on this account control?Lastly, do you think China can one day be a world class financial center?
Robert A. Mundell:China should do this when it's in its own interests. I think theadvantages of doing so would be convertibility. China would immediately be putinto the SDR (Special Drawing Rights). The absence of exchange control wouldunify the stock markets. Shanghai would move very quickly to a global capitalmarket. This would push for a lot more reforms. Credit rating agencies wouldhave to allow for more opening so they could come into China and help with therating systems. China has the potential to become a world class financialcenter.
Robert Mundell Introduction：
Professor of Economics, Columbia University1999 Nobel Laureate in Economics.He has been an adviser to a number of international agencies andorganizations including several governments, the United Nations, theInternational Monetary Fund, the World Bank, the European Commission, theFederal Reserve Board, the US Treasury, the Inter-American Development Bank,and companies and institutions throughout the world.
