The International Financial Architecture

The global financial crisis requires a global solution. A deep-seated overhaul of the international financial system is needed, but could be frustrated by political wrangling, particularly in the United States, but also in the European Union. Moreover, international coordination is complicated; without it there will be no level playing field and the resulting distortions could have serious consequences. The international monetary system (IMS) has come out of the crisis relatively unscathed, but is vulnerable to large-scale attacks on major currencies. Global imbalances have been temporarily reduced, but continue to pose a challenge in coming years. In order to strengthen the IMS and to accommodate the desire for diversification of official reserves, the proposal for an SDR Substitution Account (SA) that would allow central banks to convert excess dollar holdings into SDRs should be revived and streamlined. Eliminating the present dollar overhang and avoiding its recurrence in the future would benefit all major players in the world economy. The problem of exchange rate risk run by an IMF-administered SA could be eased by ring-fencing part of the IMF’s gold for that purpose. Ultimately, world reserves could consist of roughly one-third in dollars, euros and SDRs.