the BRICS & Asia, Internationalization, and
International Monetary System Conference
December 10-11 Hong Kong
Songzuo Xiang
Chief Economist, Agricultural Bank of China
Deputy Director, International Monetary Institute
Renmin University of China
I. Fundamental causes of international capital and exchange
rate volatility, assets bubble-bust cycles and financial crises:
seven sins of the pure dollar standard and floating exchange
rates
II. Stabling exchange rate as the nominal anchor for
stabilizing global economy: a case study of RMB exchange
rate
III. A Proposal for Action
I. Fundamental causes of international
capital and exchange rate volatility, assets
bubble-bust cycles and financial crises:
Seven sins of the pure dollar standard and
floating exchange rates
1. Great Inflation in the past four decades
2. High frequency of financial crises
3. Dramatic decline of real economic growth rates globally
4. Deterioration of global imbalance
5. Violent capital flows always leads to currency collapse and
financial instability
6. Huge augmentation of the “exorbitant privilege” of the dollar
7. Unjustness of the dollar standard and the Great bubble—bust
cycle of global economy
The First Sin:
The Great Inflation in the past four
decades
Since 1971, The growth rate of international reserve money
has been much higher than the growth rate of global real
economy. the consequence of which is that the accumulated
inflation in global economic system in the past four decades
exceeds the accumulated inflation in the whole history of the
human being.
The year of
1971
The Year of
2011
Increased by
Source of
Data
International
Reserve
Money($)
45.1b.
7,516b.
170 times
IMF
Real
Economy
Growth Rate
4.91%
(1953-1973)
3.01%(after
1973);
3.7%(20032006)
Less than 4 times
Madison
and
Greenspan
4.5%
(1939-1989)
(1980-2009) 12.64%
(1980-1990) 16.1%
(1990-2009)11.42%
Greenspan
and IMF
Inflation Rate 0.2%
(1870-1913)
According to Alan Greenspan:
1.The Great Inflation after collapse of the Gold Standard
reflects the fact that there is no inherent anchor in a fiat money
regime (the pure Dollar Standard)
2.The Moderate Inflation even a little bit deflation after 1990 in
developed countries reflects the fact that the global wages and
prices are being suppressed by a massive shift of low-cost
labor (particularly in China), which, by its nature, must come to
an end.
The Second Sin:
High frequency of financial crises
Total Crisis
World Bank
Survey(2003)
117 in 93 countries
(1970-2000)
Eichengreen
and Bordo
(1973-1997)
139(1973-1997)
44 Developed countries;
95 Developing countries
(1945-1971)
Fixed Period
38
Banking
Crisis
Currency
Crisis
Twin
Crisis
17 E
9 D
26 total
57 E
29 D
86 total
21 E
6 D
27 total
0E
16 E
7E
Key facts of financial crises in the past four decades:
1. According to World Bank Research (2003), 27 0f these crises
imposed fiscal costs equal to or exceeding 10 % of GDP.
2.The most expensive crises were those in Indonesia after 1997
and in Argentina in the early 1980s, both of which cost taxpayers
55% of GDP.
3. How much did the 2007-2008 crisis impose on these countries or
global economy? No exact figure so far, but absolutely very much
higher than any previous crisis in terms of fiscal cost and slowing
down of GDP growth.
The third Sin:
Dramatic Decline of Real Economic
Growth Rate in almost all developed
economies
The rate of real GDP growth in different regions or
countries before and after the Bretton Woods System
USA
Japan
Germany
UK
Russian
Latin
America
Africa
China
Global
Total
19501973
3.93
9.29
5.68
2.93
4.84
5.33
4.45
5.02
4.91
After
1973
2.99
2.97
1.76
2.0
-1.15
3.02
2.74
7.84
3.01
2003-2007
2.76
1.86
1.7
2.94
7.51
4.02
4.78
11.66 4.75
2008-2011
0.2
-0.7
0.68
-0.68
1.57
3.78
2.02
9.63
Source: World Bank Website
2.94
The rate of real GDP growth in different regions or
countries after Global crisis in 2008
2008
2009
2010
2011
World
2.9
-0.52
5.01
4.4
Asia
7.9
6.5
8.4
8.4
European
1.0
-4.0
2
1.5
China
9.6
9.2
10.4
9.3
USA
-0.4
-3.5
3
1.7
Germany
1.1
-5.1
3.7
3.0
Japan
-1.0
Source: World Bank Website
-5.5
4.4
-0.7
Ronald McKinnon and Kenichi Ohno Hypothesis: Generalized
exchange rates floating leads to Global Growth Slowdown.
“ The major puzzle of postwar economic history is the slowdown of
the growth trend of major industrial countries in the early 1970s.
The timing of the slowdown largely coincided with the introduction
of generalized float among those countries. Might there be a causal
link between the two events? Did weaker growth somehow
necessitate an era of exchange fluctuations? Or can we say that
the acquiescence to exchange instability led to the deterioration of
real performance?”
“Our alternative hypothesis is that the deterioration of
global economic performance is of monetary and financial
origin. We further suspect that exchange fluctuations have
much to do with it. It is plausible that reduced productivity
growth and output since the 1970s has been, at least in
part, the consequence of noisy price signals associated
with inflation and deflation, exchange misalignments, and
volatility in long-term interest rates. Dysfunction of the price
mechanism naturally reduce allocative efficiency, especially
that of physical investment.”
The Fourth Sin:
Deterioration of Global Imbalance
1. the definition of global imbalance by US Treasury
(US Trade Deficit) is totally wrong, we need redefine
the Global Imbalance.
2.My definition of Global Imbalance: Two Divergence
The First is Globally Divergence of Virtual Economy (or
Financial Economy) from Real Economy, Which means
the growth rate of virtual economy has been much higher
than the growth rate of real economy.
The Second is Geographically Divergence of Real Wealth
Creating Center from Virtual Wealth Creating Center:
The real wealth creating center (or manufacturing center)
has gradually transferred to emerging countries (particularly
China).
However, global money and financial center still remain in
developed countries (particularly USA), which has the most
fundamental implications on global division of labor, global
distribution of income, financial crisis, and all
macroeconomic policies.
Increasing divergence of virtual or financial economy
with real economy: ratio of financial assets with GDP
Financial
Assets/GDP
1980
1995
2005
2010
Global
109%
215%
316%
338%
USA
158%
303%
405%
420%
Eurozone
118%
278%
359%
380%
UK
128%
180%
303%
344%
Martin Wolf: “This huge and rapidly growing mountain of
financial assets represents promises of future, often
contingent, receipts in return for current payment.
Sophisticated and dynamic modern economies depend on
pyramids of promises.”
However, The financial promises is subject not just to
calculable risks but to fundamental uncertainty—to
“unknown unknowns”.
“That is at least part of the reason why financial crises have
been so frequent and so dangerous”
The Myth: Why the growth rate of financial assets or virtual
economy has been so much higher than the growth rate of
real economy? We have no satisfactory explanation yet.
(A) Ben Bernanke’s “ Global Savings Glut Hypothesis”
(B) Richard Duncan’s “ Global Money Glut Hypothesis”
(C) Songzuo Xiang’s “ Credit System—Virtual Economy—
Real Economy General Equilibrium Model”
The Fifth Sin:
Financial Globalization and capital flows
very often Lead to Economic Collapse
1. Why and When Did Financial Globalization Begin?
Martin Wolf: “the abandonment of the Bretton Woods
system of fixed, but adjustable, exchange rates in the
1970s marked the beginning of a new global economy. It
was the start of an era of unstable exchange rates among
the world’s most important currencies. Other events
followed. These developments led to the emergence of
the second globalization.”
2.Many distinguished people are highly skeptical of financial
globalization.
Joseph Stiglitz: “ the opening of financial markets in the
emerging market economies to foreign capital leads to
economic collapse”.
Jagdish Bhagwati: “ the claims of enormous benefits from
free capital mobility are not persuasive.”
George Soros: “ The Deficiencies of Global Capitalism.”
Fred Bergsten: “ USA and other developed countries got the
large part of benefits of financial globalization”
3. Capital flow from poor to rich countries:
The amount of private capital flowing to emerging market
countries is only one fifth of total international capital flows
from private sources. When governments are added into the
picture, emerging market countries have actually been
sending capital back to rich countries!
In 1913, over 25% of the world stock of foreign capital went
to countries with income per person less than one-fifth of the
United States, by 2007, this figure had fallen to around 5%.
4.How to explain the current pattern of capital flows?
(A) Currency Mismatch for emerging countries
(B) “fear of floating” of emerging countries
(C) “Liquidity Services” provided by the Dollar as the major
international reserve money.
The Sixth Sin:
Huge Augmentation of The “Exorbitant
Privilege” of the Dollar
1.The end of the Bretton Woods system of fixed exchange
rates has made exorbitant privilege of the dollar much more
exorbitant, as the extraordinary accumulations of foreign
exchange reserves by emerging market economies and the
cheapness of US liabilities bear witness.
2. A remarkable indication of these effects is what happened
to US net liabilities between 2001 and 2006.
The ratio of US net liabilities to GDP fell by 3.4 percent of
GDP over this period, despite current account deficits that
ought , on their own, to have raised net liabilities by 28.2
percent of GDP.
( Quoted from Martin Wolf: “ Fixing Global Finance”)
3. The returns on US assets were 3.32 percentage points
higher than the cost of its liabilities between 1973 and 2004.
However, during Bretton Woods system period (1952—
1973), the returns on US assets were only 0.26 percentage
points higher than the cost of its liabili:ties, according to
Gourinchas and Rey：“ From World Banker to World
Capitalist: US External Adjustment and the Exorbitant
privilege”.
4. the Pure Dollar Standard and Floating Exchange
rates serve US benefits much better.
The Seventh Sin:
unjustness of the dollar standard and
the great bubble-bust cycles of global
economy
1. The unjustness of the dollar standard
“ The functioning of the international monetary system was
thus reduced to a childish game in which, after each round,
the winners return their marbles to the losers.”
“More specifically, the process works this way. When the US
has an unfavorable balance with another country ( let us take
as an example France), it settles up in dollars. The
Frenchmen who receive these dollars sell them to the central
bank, the Bank de France, taking their own national money,
francs, in exchange. The Bank de France, in effect, creates
these francs against the dollars. But then it turns around and
invests the dollars back in the US. Thus the very same
dollars expand the credit system of France, while still
underpinning the credit system in the US.” ( Jacques Rueff,
1961)
We can change France to China and the Bank de France
to PBOC, and everything is absolutely true, only in much
larger scale!
2. US BoP deficit is the mechanism of creating international
reserve money and origin of the Great Bubble in Global
Economy.
Six Important Conclusions
1. The Seven Sins explain the fact that why the US has no incentive to reform.
2. The Seven Sins explain the fact that why the US always urge other
countries to float ( Now the major target is China): All nominal arguments
for RMB appreciation and flexibility have been refuted by empirical
evidences.
3. The Seven Sins explain the fact that why the US push forward financial
liberalization and globalization for almost all countries.
4. Seven Sins Explain the Fact That Global Economy as well as almost all
countries have experienced Bubble—Bust Cycles in the Past Four Decades.
5. Seven Sins Explain the 2007—2008 Subprime Crisis and Global Financial
Crisis.
6. Seven Sins Demonstrate That “ International monetary reform, after all,
could have a profound effect on the world economy and on national
economies; its impact on these countries, including the US, could be more
important than that of all the domestic measures currently being studied
or discussed.” ( Valery Giscard d’Estaing, Former French President, 1968)
II. Stabling exchange rate as the nominal
anchor for stabilizing global economy:
A Case Study of RMB Exchange Rate
1. From 1994—2005, stable RMB/Dollar exchange rate
has contributed to China’s stable price level, high and
smooth economic growth, reasonable trade balance
and stable accumulation of foreign reserve.
After unification and fixing of RMB exchange rate, China’s GDP
growth has maintained smoothly very high and inflation very low
and stable
CPI data for China from 1990 to 2001: Unification and fixing of
exchange rate have contributed significantly to reduce inflation
 2. Single-sided appreciation of RMB against dollar since
July 21, 2005 has not achieved the claimed objectives:
 (1) correct Sino-US trade imbalance? NO
 (2) stabilizing China’s price level and inflation
expectation? NO
 (3) increasing and strengthening monetary policy
independence of PBC? NO
Since July 21, 2005, nominal RMB against Dollar has appreciated more than
25% (from 8.28 to 6.22), even more in terms of real exchange rate
CPI data for China from 2002 to 2012: after single sided appreciation of
RMB exchange rate, China’s inflation has become much more volatile
The average price of housing in China Unit(yuan/m2): single sided
appreciation expectation has triggered assets bubble particularly in
real estate market
2012/9
2012/5
2012/1
2011/9
2011/5
2011/1
2010/9
2010/5
2010/1
2009/9
2009/5
2009/1
2008/9
2008/5
2008/1
2007/9
2007/5
2007/1
2006/9
2006/5
2006/1
2005/9
2005/5
2005/1
2004/9
2004/5
2004/1
2003/9
2003/5
2003/1
2002/9
2002/5
2002/1
The Sino-US trade surplus : Unit(billion dollar). appreciation has
not reduced Sino-US trade surplus
25.00
20.00
15.00
10.00
5.00
0.00
 After RMB appreciation, Sino-US trade surplus has
been expanded significantly which refutes empirically
the argument for flexible exchange rate adjustment
 3. single-sided appreciation of RMB against Dollar has
almost exact opposite effects
 (1) Sino-US trade balance has worsened
 (2) hot money and speculative capital inflows has
increased dramatically
 (3) monetary independence of PBC has been reduced
significantly
 (4) assets bubble particularly in real estate market has
become very serious and led to the most tightening
policies in 2010
Appreciation forces PBC to intervene massively. Since July 21, 2005,
foreign reserve accumulation by PBC has increased by 450%
 Conclusions:
 1. we need an credible anchor for monetary policy
 2. flexible exchange rate couldn’t be an anchor or rule for
monetary policy
 3. countries other than international reserve issuing
country cannot afford and manage fully flexible
exchange rate
 4. fixed and stable exchange rates are not incompatible
with capital account liberalization, interest rate
liberalization and internationalization of a currency
 5. stable capital inflows and exchange rates are
prerequisite for stabilizing global economy
III. A Proposal for Action
1.To Create Multiple System of International
Reserve Money and Reduce Monetary
Dependence on the Dollar
(A) To Stabilize the Euro
(B) To encourage Regional Monetary and
Financial Cooperation.
(C) To promote RMB international use
2.To Create A Multiple Agreement for Exchange Rates Stability
(MAERS ) Among Major Countries ( Eurozone, USA, Japan,
UK, China, etc.)
(1)New Version of Bretton Woods Fixed Exchange Rates
System.
(2)The Key is to stabilize the Dollar—Euro exchange rate.
(3) European Union Can Offer Proposal to USA
(4) European Union and China can jointly take initiative at the
next G20 Summit.
(5) Consider Bob Mundell’s DEY (Dollar –Euro-Yuan)
exchange rate system
Different perspectives for IMS reform
Three perspectives
for IMS
Reserve money
Exchange rate or
adjustment
mechanism
International last resort
of lender
USA
Dollar is the best
Floating
IMF
Eurozone
Continue to
Expand Euro
Stable Exchange
rates
IMF+ ESM
Emerging Countries
Multiple reserve
money
Stable or fixed
exchange rates
Reserve Pool or
mutual assistant
mechanism
Q&A