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Might the US champion reform?

A few years ago, there was much excitement amongst monetary reformers when the governor of the People’s Bank of China made a speech championing reform. But China did not follow up that initiative – indeed, officials downplayed it, saying that Governor Zhou had been speaking in a personal capacity. Then came President Nikolas Sarkozy, who promised to make France’s presidency of the G20 into a force for reform; he pointed to excessive instability of exchange rates; excessive instability of commodity prices, and poor governance. I myself heard Mrs Lagarde, as France’s finance minister in 2010, say that France wanted proposals to make sure that the system served growth and global coordination more effectively. Reliance on a single currency fomented instability, she said. But this challenge also faded. Meanwhile the troubles of the euro zone have scuppered the hopes of reformers that the single currency could pose a credible alternative to the dollar any time soon.


But this is not to say that the foundations of the dollar’s role at the centre of the system have been strengthened. On the contrary, they continue to weaken.


Robert Mundell has pointed to five perceived problems of the international monetary system (speech on “Dollars, Euros, Yuan and the International Monetary System” Beijing, November 9, 2012).


  • No international currency anchor for fixed exchange rates.
  • Two big currency areas with unstable $/€ exchange rate.
  • Swings in Dollar-Euro rate are destabilizing for third countries.
  • China In International Disequilibrium
  • Weak International Monetary Authority


How can we start dealing with such a daunting list of issues?


Not since Bretton Woods in 1944 have sensible would-be monetary reformers looked to the US for a lead. Everybody knew that the prevailing system suited the US. So long as the original Bretton Woods scheme worked to its advantage, from 1945 to 1971, the US championed it, complete with fixed exchange rates and the gold link of the dollar. When inflationary financing of the Vietnam war made the dollar peg politically inconvenient, the US discovered the joys of floating and turned against gold. Ever since, its official position and that of the great majority of American economists has been anti-fixed rates and anti-gold. The strategic aim throughout was to maintain a competitive exchange rate.


But are things beginning to change? Now that the system can no longer deliver such a competitive edge, can we look to the US itself to initiate reform?  Who knows? The problem is not only that other countries tend to float down with the dollar (the ECB can’t afford to let the euro get too strong, and nor can Japan allow the yen to go back to its former peaks), thus locking the US into an uncompetitive exchange raTe. It is, rather, dismay in the US itself at looming monetary anarchy.

US considers new monetary probe

Kevin Brady, chairman of the Joint Economic Committee of Congress, and over a dozen original co-sponsors, earlier this month proposed a bill to create a bipartisan national Monetary Commission.  The Centennial Monetary Commission is being put forward as a neutral forum.  Its proposed terms of reference present a range of policies for assessment: discretion (the current policy); price level targeting; inflation rate targeting; nominal gross domestic product targeting; rules; and the gold standard.


The Monetary Commission is being proposed by the well-respected chairman of a very distinguished bi-partisan, bi-cameral legislative body.  It is designed to be an empirical, rather than doctrinaire, body.  It would review the data relating to a wide variety of alternative monetary policies, including but by no means limited to gold.


In the space of a few days since being introduced, the legislation has received extraordinary publicity — several columns, including two by Ralph Benko. in,  one by  Charles Kadlek  and an excellent article by Seth Lipsky entitled “A Commission for the Fed’s Next 100 Years” in the Wall Street Journal on March 25.


Recently, when Virginia came very close to enacting its own state-based monetary policy assessment commission for US dollar policy, a simple, very neutral, news report in the Washington Post drew 1300 reader comments, an extraordinary number by any measure, implying that the voters really are becoming extremely anxious about monetary policy and want Washington to take it more seriously.


The reform movement draws political strength from the sense that the Fed has lost its way. It missed the warnings on the way up to the 2008 panic and, as the fragility of the recovery shows, continues to struggle.  There is no clear exit strategy from present extraordinary monetary easing. All the proposals involve huge risks for financial stability. Everybody can see that. Meanwhile, the JEC is one of the most respected bodies in Washington, a respect it has earned over many years.


I have in the past strongly defended central banks from threats of political interference. But the world has changed, and it seems to me that the present system of inflation targeting with floating and unstable exchange rates bears part of the responsibility for the origin, severity and persistence of the global crash. I am not persuaded that making central banks responsible for macro-prudential supervision, raising of capital ratios on banks and the rest of the regulatory apparatus, will improve the stability of the system. It should be added, also, that many supporters of this initiative do not view it as threatening  “interference” but as a sincere and honorable effort to  disintermediate politics (which perforce always sacrifices the long term benefits to short term benefits, sometimes correctly but sometimes in a damaging way) from the policy process. It is the present central banking system that, from this angle, has succumbed to the political process.


In terms of US politics, stagnation has resulted in high unemployment and a stubbornly high federal deficit.  Voter distress is growing. The more desperate the central bank gets in its efforts to spur growth – “helicopter money” and so on – the deeper the distrust and uncertainty in the general public. It is true that talk of hyperinflation is overdone. But in its 100th birthday year, the Fed cannot be happy at the widespread sense that it does not really know what it is doing or what to do next.


If this commission is formed , its findings could be both constructive and influential. It could point the way towards meeting the first and most important of the problems identified by Mundell.