Author: Carlos Pereyra

Summing up of a presentation by Julio Velarde (Governor, Central Reserve Bank of Peru) at a Meeting on “Where is Global Finance Heading?” (Cusco, Peru, July 2009)

Published in “La Moneda” Magazine, Central Reserve Bank of Peru (Spanish)

Governor Velarde’s presentation focused on global imbalances, possible shifts in the international monetary system, and the reform of the international financial architecture. Regarding the first subject, Governor Velarde indicated that, even as multilateral imbalances have receded during the crisis, they are still considerable, and will probably continue to be so in the medium term. Unlike in the 1980s, when appreciation of the yen and the Deutsche mark helped to reduce imbalances under the Plaza Accord, such process is not taking place yet. The dollar has depreciated against the euro and the yen, but not against a number of other currencies.

Moreover, emerging economies are strongly linked to those imbalances. Especially, many of them are not allowing their currencies to appreciate fast enough. Their holdings of U.S. Treasury bonds (T-bonds) have been increasing, even after the demise of Lehman Brothers. China alone holds around 35 percent of outstanding T-bonds; and BRIC and OPEP central banks explain 63 percent of the increase in T-bond holdings between April 2008 and April 2009.

One possible mechanism to resolve global imbalances is to increase Chinese consumption. However, it must be kept in mind that consumption is only 35 percent of China’s GDP; and that Chinese banks are more experienced in extending credit to firms than to consumers. It is necessary to introduce measures such as enhancing health insurance and retirement benefits to limit China’s excessive private saving, which represents up to 50 percent of GDP. Consumption growth will probably continue to be subdued in surplus countries (including Germany and Japan). Additionally, Edwards (2006) suggests that higher growth in Europe and Japan would contribute only modestly to narrowing the U.S. external gap.

In this context, there is uncertainty regarding the dollar’s strength. Is it possible to foresee a fundamental change in the international monetary system? According to Governor Velarde, it is reasonable to suppose that dollar dominance will continue, but will recede as alternative reserve currencies increase in number. In his view, the dollar will continue to be the main reserve currency, due to the predominance of investment in dollar-denominated assets and to the liquidity and depth of dollar markets; but that over the next years the use of other currencies as reserve assets will expand beyond the euro, to include the currencies of several emerging economies, probably starting with investment-grade countries with no capital controls. He emphasized that it is normal to diversify risk by investing in a range of assets; and that, from a historical perspective, dominance of a single reserve currency has been the exception rather than the rule (in the interwar period there was a dollar-sterling duopoly, which in turn had replaced a sterling-French franc-Deutsche mark oligopoly.) Along these lines, he stressed that financial innovation -in spite of the unfavorable reputation it has earned as a result of the current crisis- and globalization make us all more similar; and that these developments are likely to foster the use of assets denominated in several tenths of different currencies. He mentioned that currently the People’s Bank of China (PBC) already holds more than 44 percent of its foreign assets in currencies other than the dollar; and recalled that, until not long ago, it was all but inconceivable that Peru could be able to issue 30-year bonds in domestic currency, and a that a large share of them could be demanded by foreign investors.

Governor Velarde pointed out as well that, within this diversification process, lately the PBC has sought actively to establish swap arrangements with several countries (mainly in Asia and Latin America) to enhance the yuan’s role in the world economy. Governor Velarde also said that Peru has potential access to the IMF’s new Flexible Credit Line (FCL), a precautionary instrument aimed at economies with solid macroeconomic fundamentals. Particularly, he emphasized the efforts displayed by multilateral agencies to increase, and give more flexibility to, the provision of financial resources to contribute more effectively to the resolution of the global crisis. In addition to the creation of the FCL, the IMF has raised access limits significantly, increased bilateral financing, strengthened its capacity to provide financial assistance to low-income countries, and approved a substantial increase in Special Drawing Right (SDR) allocations. He also said that it has been suggested that the IMF take on a role of lender of last resort, not only to countries, but also to internationally relevant banks -which would have the advantage of preserving financial rescue operations from political pressures and handing them over to the IMF’s technical staff. Finally, he pointed out that it is necessary to reinforce multilateral agencies’ capacity to improve international coordination in macroeconomic policy and financial supervision and to resolve multilateral distortions (mainly by providing international liquidity to markets that need it).

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