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Monday, July 31, 2000

Third phase of monetary rule prompts G8 to renew focus

This year's Group of Eight summit was concluded over the weekend in Okinawa, wrapping up a series of meetings that began July 8 with the G8 finance ministers in Fukuoka.

The wide range of topics discussed at these meetings can be split into two categories:

* future issues, like information technology and genetically modified foods;

* and systems that supported the post-World War II structure of the world but are being criticized today for being out of sync with the changing times. These institutions include the United Nations, the International Monetary Fund and the General Agreement on Tariffs and Trade, as well as its successor, the World Trade Organization.

It was the international currency chaos and a surge in world oil prices that prompted leaders of major industrial powers to launch their first summit meeting in 1975.

With the world witnessing a similar situation today, I would like to examine here the changes that have occurred in the international monetary system since the end of WWII.

The postwar international monetary system, anchored by the IMF, is in its third phase.

The first phase, of course, refers to the years under the gold-dollar standard and the adjustable fixed exchange rates. This period was characterized by the overwhelming economic power of the United States, and it was deemed important for each country to maintain a balance in its current account. The U.S. dollar was convertible to gold, and the dollar was in short supply. The amount of foreign currency reserves was a major factor in Japan's fiscal and monetary policies.

The second phase began in the early 1970s with the so-called Nixon Shock, or the end of the dollar's convertibility to gold, and the subsequent introduction of the floating exchange rate system.

During this phase, policymakers no longer viewed the country's current account balance with the same importance. It was widely assumed that a nation's current account will eventually be brought into balance with the help from the adjustment functions in the floating rate system, and that any temporary deficit should be made up for by funds from the capital account. The two world oil crises during the 1970s, along with the need to recycle oil money to cope with the emergencies, gave additional impetus to this thinking.

These events were also the ones that prompted the major industrialized powers to start their annual summit meetings and discuss how to cooperate and cope with the changes. But the U.S. dollar remained the only key world currency, and no effective actions were taken to halt the free outflow of the dollar.

The start of the third phase was triggered by the Asian currency crisis of 1997 and the collapse of U.S. hedge funds.

After the events unfolded, it became widely recognized that the rapid inflow and outflow of capital does not necessarily lead to economic growth and could instead cause economic chaos. The issues of how to properly monitor and control the capital movement caused by the dollar's free flow and how to devise currency management methods that fit each country's level of development have become pressing tasks for policymakers.

Since the Cologne Summit of last year, the issues have become a major topic of discussion among industrialized powers, and various proposals have been made at IMF meetings and G7 conferences. It is noteworthy that policymakers are beginning to reconfirm the importance of the current account balance. Despite the continuing weakness of the dollar, the U.S. current account balance is not improving, and the world's financial leaders are starting to realize that the uncontrolled outflow of the dollar is the biggest factor behind the currency and economic confusion that has been witnessed during this phase.

In addition, the scheduled start of the euro's circulation in the real economy, despite lingering uncertainty over the future of the new currency, has begun to brake the outflow of the dollar somewhat.

Currency exchange is the rate of conversion between two currencies. Even in an era of globalized economies, it will be impossible to stabilize currency exchange while leaving the current account imbalance unattended. This is why this year's G7 statement referred to the savings shortage in the U.S., which maintains a current account deficit, and the need for Japan to stimulate domestic demand.

The G8 leaders said they realize that IMF lending schemes and the ratio of each member's financial contribution, both of which date back to the years just after WWII, must be reviewed. They also welcomed efforts for regional currency cooperation to prevent a recurrence of the Asian crisis. However, one must not forget that, despite the influence of globalization and the IT revolution, what is essential for stable currency exchange is for each country to maintain sound management of its own economy.

Teruhiko Mano is an adviser to BOT Research International Ltd.

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The Japan Times

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