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| Dr. Kemal Derviş |
Q: Since the financial crisis of 2008, the world has witnessed a period of economic recovery, thanks to the unprecedented fiscal expansion and monetary easing measures introduced by several countries around the world. However, many economists fear this recovery is not self-sustaining and is still on life-support. Do you support this view?
A: Well, I think you are correct in saying that unprecedented fiscal expansion and monetary easing played a huge role in stopping a really catastrophic recession. The scale of the fiscal and monetary policy expansion was historic but it was the right and only thing to do given the enormity of the crisis. Now we are in a recovery phase, but the recovery is very uneven. On the one hand, the emerging markets—in East Asia, South Asia, Brazil and my own country Turkey—have recovered strongly, but advanced countries—like the US and Japan—are still in a much weaker position, although they are out of recession. For example, the US is experiencing a recovery but with very little job creation. Then there are many structural problems in advanced countries, such as the problem of an ageing population, which is causing big fiscal concerns, budgetary problems and healthcare issues. On top of all this is the fiscal expansion and all advanced countries, some more than others, are now faced with major budgetary adjustment problems. Now, the challenge will be on how to continue to support the recovery, even as governments have to engage in deep reforms on the fiscal side. This is not going to be easy.
Q: Do you think the dollar-based international monetary system suits the global economy considering the US frames its monetary policies to serve its interests?
A: I think the international monetary system, the behavior of reserves and exchange rates, was very closely linked to the way the crisis ensued, mainly because too much liquidity was coming into the US and so the combination of this excessive liquidity with the lack of good supervision of the banking system and the risky behavior of the banks led to the crisis. So I do believe that a healthier flow of capital and management of international liquidity is needed. It is not natural for some countries to have huge surpluses and for some to have huge deficits, as then liquidity accumulates on one end and does not flow onto the other. At the same time if you look at the matter from a historical standpoint, you find that international monetary systems are the result of the decisions of many economic actors, so you cannot really dictate a system from the top. It would simply not work. Currently, we have a system which is not a very good one and is dysfunctional.
A: I think the international monetary system, the behavior of reserves and exchange rates, was very closely linked to the way the crisis ensued, mainly because too much liquidity was coming into the US and so the combination of this excessive liquidity with the lack of good supervision of the banking system and the risky behavior of the banks led to the crisis. So I do believe that a healthier flow of capital and management of international liquidity is needed. It is not natural for some countries to have huge surpluses and for some to have huge deficits, as then liquidity accumulates on one end and does not flow onto the other. At the same time if you look at the matter from a historical standpoint, you find that international monetary systems are the result of the decisions of many economic actors, so you cannot really dictate a system from the top. It would simply not work. Currently, we have a system which is not a very good one and is dysfunctional.
Q: Do you really mean the system is dysfunctional? Would you qualify it in such harsh terms?
A: Yes, the current international monetary system is dysfunctional because it allows the US to run large deficits without really creating the pressure for an adjustment, because they can really just print the money. That said the dollar still remains the most liquid asset by far. The financial markets still consider it as almost the only asset that can be held in the long term.
The euro has become a little bit of an alternative but the problems in the south of Europe have somewhat undermined the confidence. The Japanese yen is a good currency that everyone wants to hold but it does not have the dimension of the dollar. The sterling is still surviving amazingly, but again it has limited value and the renminbi is now becoming a very important currency in the world, but because the Chinese capital markets are fairly closed it cannot be easily transacted. Therefore, in spite of all the problems the dollar still remains very dominant and very desirable. So I don’t think there will be an immediate change, but a gradual change.
I personally believe that we are moving from a uni-polar system in the world of economic and financial power, as was characterized in the 1990s, towards a multi-polar system where we could see China becoming one major pole and Europe (despite its divisions) becoming another. In the same vein, Japan would continue to be an important economy and India is expected to become an increasingly important economic power in terms of its size with 1.2 billion people. So in the next 10-20 years I believe we would see a reflection of this change in the international monetary system. The big question is, will we move toward a system of two or three major reserve currencies, with the Chinese yuan undoubtedly becoming a reserve currency, or will the international community be able to create a synthetic asset, like the SDR (Special Drawing Rights), which might play a much bigger role. I think, this is the big question.
Q: But there is also some talk in certain conservative circles of going back to commodity-based currencies like gold or a basket of commodities. Do you think it is a feasible proposition?
A: I do not think it is viable. The interest in gold has been revived because of the present difficulties but there is no rationale in going back to a commodity backed system, in my view.
You see, history does not tend to go back, it tends to go forward. I think the world had a gold standard, but it was not really appropriate because in a way it was arbitrary, begging the question why gold and not copper etc. Moreover, it also limits the policy space of governments, and governments don’t like that.
Q: There are some that say gold-backed currency would also limit derivatives trade and other shadow banking activities because it would restrict monetary expansion?
A: I don’t think so, because you can trust them to invent very complicated derivatives based on gold. At the same time, governments will not give back to gold their monetary policy space. I think it is more likely, that just as we moved from gold to dollar standard, one day the US dollar would be less important than an SDR or an SDR-like system. In fact, this will be a more appropriate reflection of the world of the 21st century. So I think a cooperative system, with the SDR as a basket of various important currencies, managed by the international community eventually will come into existence, but this may take decades.
Q: Should the GCC states be wary of a sudden fall in the value of US dollar reserves?
A: I don’t think the dollar will lose its reserve asset position dramatically. But what might happen to the exchange rate, nobody knows. I would argue that some diversification is a good thing, but sudden diversification is not because that would hurt everybody and it would hurt the international system. Whether it is the GCC countries or China—that sits on huge dollar reserves—there is a worry on what happens if these reserves lose value. And that is why we come back to the question of the system. The system is not functioning properly because you want to accumulate reserves and at the same time you worry about the value of these reserves. If your reserves constitute a basket of currencies—including the dollar, the euro, the yen, the yuan, the swiss franc—then one would be safer because all of them would not lose value together. I think we will move towards that system, but I think the movement should be gradual and careful and should not upset the equilibrium in the world economy.
Q: Do you think the global financial system is prone to another crash like that of 2008?
A: These days, especially after the 2008 financial crisis, one cannot completely discount such possibilities.
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