International monetary system in urgent need of an overhaul

Liu Mingkang, the former chairman of the China Banking Regulatory Commission.

Dollar should be replaced by use of several currencies in global trade and investment

The Bretton Woods system was born 70 years ago and died 44 years ago - too short a life. Nonetheless, in the post-Bretton Woods era, the world has enjoyed the benefits of floating exchange rates, but it has also experienced panics, such as the Mexican and Asian financial crises, the collapse of the dotcom bubble and the 2008 global financial crisis. We have seen technological developments nobody dreamed of, along with geopolitical power shifts and competition for world economic power.

The international monetary system has many unsatisfactory aspects. Major currencies function as international money (the medium of global transactions, store of international wealth, international unit of accounting). Each central bank has responsibility over its currency and pursues policies that are in the national interest. Little or no regard is paid to the global interest.

For many years, we have had globalized financial markets, with generally open capital accounts and free capital flows that provide diverse investment opportunities and funding sources. However, we have also seen that capital flows are volatile and even dangerous, particularly for small and medium-sized open economies. Since Bretton Woods broke down, there has been too much monetary and financial instability.

The economic dominance of the United States has led to the dollar's international monetary dominance. That has yielded privileges for the US in running large, sustained current account and budget deficits. Lacking a better choice, emerging markets finance US deficits in return for monetary and financial stability and as a source of safe haven assets.

Though improving, US economic numbers are neither truly better nor more stable. In addition, the US has monetized its budget deficits, which is usually a recipe for monetary and financial disaster in jurisdictions with no such currency privileges. Six years after the global financial crisis, the bubble that has not burst is likely the market for US Treasury bonds and other G7 Treasury bonds.

We face an unstable equilibrium in the international monetary system with huge risks for the global economy. We must quickly deal with these weaknesses.

1. National monetary policies should be better coordinated.

The US is reversing, or tapering, its quantitative easing policy. The markets expect the US Federal Reserve Board to raise interest rates in 2015. All things being equal, this move could cause huge cross-border capital flows. Emerging economies that have suffered from a huge dollar trap (the accumulation of dollar reserves) may experience sudden capital outflows.

Red flags have appeared. Eurozone bonds have fallen to 200-year lows and emerging markets are particularly vulnerable. We all know that fiscal and monetary stimulus with lax regulations will promote artificial growth and asset bubbles, and we also know that once these themes slow or reverse, the consequences could be significant. We need better coordination to ensure stability.

2. Information sharing and disclosure should be improved.

The Special Data Dissemination Standards and General Data Dissemination Standards are good efforts by the International Monetary Fund to institutionalize data sharing, but more could be done.

The most striking issues over the past 44 years have been that: a) many central bankers and finance ministers have not had adequate mandates to share data and b) if such mandates exist, they are often unwilling to share, particularly during times of economic stress. The IMF must strengthen its sanctions and incentives to ensure that necessary, quality information is shared among member countries.

3. Capital movements should be better monitored and managed.

Yield-driven behavior by investors is exacerbating cross-border capital flows, which can destabilize both national and international financial markets. Countries should sequentially liberalize their capital accounts in line with efforts to strengthen their governance. The IMF should encourage countries to adopt suitable policies, such as Tobin tax-like approaches, to sterilize capital flows.

4. Cooperation and coordination should be at all levels.

International cooperation and coordination should be a strong focus. The IMF and Financial Stability Board should share data, analytical frameworks and staff, and all nations should do likewise.

I stress this point because this is a political process, and we are disappointed to see that quite often, national interests override the global interest. Changing that requires extraordinary political vision, wisdom and courage.

5. The role of a multi-currency system should be recognized.

We should seek an international reserve currency that is disconnected from any individual nation and can be neutral and stable in the long term. Until that point, a multi-currency system should be used more in international trade, investment and payments.

Shifts in economic power are unavoidable and currencies should reflect that, as was the case in the 1940s. At the very least, such a move will supplement the current dollar-dominated system.

Returning to Bretton Woods or passively retaining the current system would both be unwise. With effort from all countries, we may be able to create a more robust and flexible system. We must also remain on guard against panics and shocks.

The author Liu Mingkang is the former chairman of the China Banking Regulatory Commission.