Perhaps this policy discussion may cast some light on the efforts of the paper-producing nations to dampen global commodity prices and control certain geographic areas of essential resources.
At some point the Rest of the World may realize that having any nation's fiat money as the international reserve currency is nothing more a thinly veiled form of colonialism.
Policy is a matter for The World, not just a Rich Club
By Jean Pisani-Ferry
The Financial Times
August 12 2008 19:40
As the collapse of the trade talks in Geneva in July made clear, there is no longer any meaningful trade negotiation without the main nations from the emerging world. The year 2008 may go down in history as the one in which rich countries discovered that this applies to macroeconomic policies, too.
In January it looked as if the opposite lessons could be drawn from events. For a while, Ben Bernanke at the US Federal Reserve and Jean-Claude Trichet at the European Central Bank seemed to be the only relevant policymakers in the world – and they were, as far as liquidity strains were concerned, if only because the US and Europe account for about two-thirds of the global supply of financial assets.
But as months went by, it became clear that countries affected by the shock represented merely a half of world gross domestic product, two-fifths of global energy demand and not even a third of world cereal consumption. Furthermore, rich countries have significantly less weight at the margin: their contribution to world growth is about half their share of world GDP, so one-quarter of the total, and the same rule of thumb applies even more to the demand for oil and foodstuffs. So in the market for scarce commodities, the effects of the slowdown in the US and Europe were offset by domestic booms in the emerging world.
By the end of spring, policymakers in the Group of Seven leading nations had awoken to an uncomfortable reality that focusing on a regional financial shock had led them to ignore a global commodity shock. Worse, thanks to the fact that most emerging and developing countries in Asia and the Gulf were part of a de facto dollar zone, actions taken by the Fed to address financial stress in fact compounded runaway domestic demand in those countries and fuelled global hunger for commodities. In spite of rising inflation, real interest rates in the main emerging countries are still inappropriately low or even negative.
Stagflation is not here to stay. East Asia is unlikely to remain immune from current near-zero growth in Europe (to where it exports about 5 per cent of its GDP) or, even more, from forthcoming deterioration in the US (to where it exports almost 7 per cent of its GDP). Commodity prices have started to decline. However, the underlying issue will not go away, for two reasons.
First, lingering scarcity of fossil energy and agricultural commodities is likely to remain and to change the macroeconomic scene significantly. For about two decades, since the start of the current wave of globalisation, it seemed that there were no real speed limits to global growth. Disinflationary forces coming from the increase in the global labour force and the weakening of organised labour were powerful enough to ensure an environment of low prices worldwide. This Goldilocks era has ended and the world economy is likely, over and again, to test the speed limit stemming from constraints on the supply of commodities.
Second, in the same way German unification revealed the fault lines in the European monetary arrangements of the 1980s, the current episode has exposed the fault lines in the so-called “Bretton Woods 2” arrangement, whereby a large part of the emerging world pegs to the US dollar. But for the direction of the shock (a boom then, a slump now), what is happening now is in many way a repetition of what happened then to the European exchange rate mechanism: here, a shock to the anchor country that desynchronises it from its monetary bedfellows.
So the question is: what do we need to manage interdependence better? A straightforward solution would be for the main countries or groupings to target domestic inflation independently in the context of flexible exchange rates. The proviso is that for such a solution to work participants would have to target total, not core, inflation (this may seem obvious but it has apparently escaped some policymakers, who claim that there is nothing they can do about inflation because it is not home-made). This is more or less the arrangement industrialised countries came to a decade or so after the collapse of Bretton Woods. It involves minimal co-ordination and can accommodate differences in preferences. In the European case, it has proved compatible with tighter regional agreements – including a single currency.
The problem is that a large part of the emerging world, starting with China, is not ready for independent floating. There are genuine obstacles to it, such as incomplete financial liberalisation and resistance stemming from the fear of uncontrolled appreciation. However, there is no reason why a preference for managing exchange rates should imply the status quo remains. Adjustments are needed and the current de facto dollar pegs are often at odds with the countries’ foreign trade. From basket pegs involving currencies other than the dollar, especially the euro, to innovative solutions such as the commodity peg advocated by Jeffrey Frankel of Harvard, there is a large menu of options to choose from for reformers looking to strengthen domestic and world stability.
But with managed exchange rates comes closer policy interdependence. If they are to remain prevalent in one form or another, there will need to be more co-operation in setting reference rates and monitoring aggregate demand. This implies multilateral discussions on exchange rate arrangements as well as on domestic demand policies and domestic subsidies to oil and food consumption. From an institutional standpoint, this also implies going beyond the existing loose arrangements or mere lunch invitations such as the last G8 summit in Hokkaido. The G7/G8 is not the appropriate forum for macro-financial matters any more. A frank policy dialogue between emerging and developed countries requires an appropriate venue.
The one option that is not advisable is to ignore the lessons from this year. For some time now, globalisation has been increasingly difficult to sustain politically, in spite of having brought income gains and low prices to the citizens of the advanced economies. It will already be much harder to convince the same sceptical citizens that they must accept it despite the fact that it brings higher commodity prices and lower incomes. It would simply be impossible to make the case for it if, in addition, it were to be perceived as a source of enduring instability.
Exchange rate arrangements and their implications for global macroeconomic management should thus be a priority topic for the international community and especially the International Monetary Fund. The Fund is looking for a renewed purpose; here is one that belongs to its core mission and where it has no substitute. Success, however, will only be possible if the G7 countries admit that the days when they were running the show are over.
The writer is director of Bruegel, the European think-tank
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