Over the past three decades, the growth of cross-border trade and capital flows has progressively woven national economies into a global economy. This global economy, however, lacks a global currency. The currency of one nation - the United States - still serves as the currency of international transactions. This is an anomaly that makes the global economy prone to periodic crises. Even in the best of circumstances, US monetary policy quite naturally is conducted with perceived interests of the US economy in view. Yet it has consequences for the global economy which could easily be adverse; we have no reason to suppose that what is good for the US economy is always and necessarily good for the global economy. Add to this the fact that the US enjoys what Robert Triffin had aptly called "exorbitant privilege"; it can live beyond its means for a prolonged period because other countries are willing to exchange real goods and services for dollars, which they can hold as asset. So, unlike virtually any other country in the world, the US can keep printing money over a fairly long period to finance wars or to accommodate external economic shocks or to pursue Keynesian demand stimulation. The "exorbitant privilege" makes the US prone to "expansionism" in monetary policy. As a matter of fact, US monetary policy has been persistently expansionary in the period since 1997, a period that witnessed as many as three "boom-bust" episodes - the "dot-com bubble", the "housing bubble" and the "commodities bubble". The short-term real interest rate in the US fell from 2.7 per cent in 1997 to -2.5 per cent in 2008. The long-term real interest rate fell from four per cent in 1997 to -0.2 per cent in 2008. The "dot-com bubble", in the making since 1997, burst in 2000. And the "housing bubble", which had been building up since the late 1990s, burst in 2007. A quick "boom-bust" in commodities followed. Thus came the financial crisis in the US and with it the global economic crisis. The response to the financial crisis was more of the same: namely, expansionary monetary policy. This now required a pure money printing programme called "quantitative easing" since, by the end of 2008, the short-term nominal interest rate had already fallen to a level close to zero and hence could not be pushed down any further. What does persistently expansionary monetary policy in the US do to the global economy? It stimulates cross-border trade and financial flows in the first instance.
Declining interest rate keeps expanding domestic aggregate demand in the US, which spills over into increased demand for imports (particularly since the US has stopped producing many of the consumer goods that it can import at a lower price from the emerging economies) and results in a growing trade deficit. This means the growth of exports from the emerging economies and substantial trade surpluses for some of them. On the other hand, low interest rates do not necessarily discourage domestic saving (much of which is institutional - pension funds, endowments, mutual funds, etc.) in the US; it generates outflows of domestic savings in search of better return. And that means increased flows of foreign institutional investment to the emerging economies where stock markets boom and currencies appreciate. Since currency appreciation hurts their export prospects, the emerging economies try to limit it by resorting to at least partial sterilisation and thus accumulate US dollars, which they put away as foreign currency reserves in the US either as bank balances or in the form of US government bonds and treasury bills. This is how what are called "uphill flows" are generated. Growing financial outflows from the US means growing financial inflows into the US so that low interest rates continue to reign there. Thus the persistently expansionary monetary policy of the US, while bringing benefits to the emerging economies and stimulating global economic growth, also nurtures bubbles of one kind or another in the US itself by generating a desperate search for reasonable return on finance in a world flush with liquidity. And a bubble must burst in due course, thereby generating a global financial crisis, which of course inflicts substantial costs on many of the very same emerging economies. The conundrum is that a policy of monetary contraction in the US today would also nurture bubbles of one kind or another, given the global dollar glut created by years of money printing. For a policy of monetary contraction can no longer bring about a real contraction of money supply in the US. Any rise in the US interest rate will induce outflows of finance from the emerging economies to the US - thereby bringing down the interest rate there. For many of the emerging economies, this would mean sudden and deep depreciation of currencies, stock market crash as also grave problems of financing trade deficits and debt repayments; we have already witnessed such consequences of "tapering" in the US for the BIITS countries - Brazil, India, Indonesia, Turkey and South Africa. The resulting economic crisis in emerging economies would further increase the flow of finance to the US, where, in consequence, there would be too much liquidity - leading to the build-up of a "bubble" that will burst in due course. Thus it is hard to see how periodic economic crises can be averted in a global economy that must do with a local currency. The emerging economies cannot do much to influence US monetary policy. And in any case the US, after years of expansionary monetary policy, is itself caught in a bind now; its money supply can only be reduced through the bursting of bubbles; which consequence would immediately call for expansionary monetary policy as a remedial measure. If the emerging economies wish to shield themselves from the devastating consequences of global economic crises, they have to partially pull back from the global economy. While remaining open to flows of trade and foreign direct investment, they have to become closed to flows of foreign institutional investment. If the global economy is to flourish, a global currency will have to be invented soon.
The writer is honorary professor at the Institute for Human Development, New Delhi