Tuesday, May 12, 2015

BIS: Time to Think about New Global Rules of the Game?

We often cite speeches and articles found on the Bank for International Settlements (BIS) web site here on the blog. This is because the BIS and the IMF are the two most influential global financial institutions in the current monetary system. If we are going to see major change in the system, these two organizations will be in the middle of that change.

This article contains remarks made by BIS General Manager Jaime Caruana at the recent IMF meetings in Washington DC. The title of the article is "The International Monetary and Financial System: Eliminating the Blind Spots". The article talks about potential blind spots in the current system that need to be addressed. In this article we will just focus on the key points. To get the full context, readers should read the full article. Below are some selected quotes with my added comments just below each quote in bold type.

"In my panel remarks, I would like to concentrate on an important blind spot in the system. The current IMFS (international monetary and financial system) consists of domestically focused policies in a world of global firms, currencies and capital flows – but are local rules adequate for a global game? I shall argue that liquidity conditions often spill over across borders and can amplify domestic imbalances to the point of instability. In other words, the IMFS as we know it today not only does not constrain the build-up of financial imbalances, it also does not make it easy for national authorities to see these imbalances coming."

The underlined text above is a theme repeated several times in this article. The author believes that having rules based on individual national interests creates systemic problems at the global level. This is an argument you often see from both the IMF and the BIS.

. . . . . 

"Let me briefly characterise the present-day IMFS, before describing the spillover channels. In contrast to the Bretton Woods system or the gold standard, the IMFS today no longer has a single commodity or currency as nominal anchor. I am not proposing to go back to these former systems; rather, I will argue in favor of better anchoring domestic policies by taking financial stability considerations into account, internalising the interactions among policy regimes, and strengthening international cooperation so that we can establish better rules of the game."

The last part of the underlined sentence is key here. It calls for "strengthening international cooperation so that we can establish better rules of the game." Establishing better rules of the game would mean we would see monetary system change. That is what we cover here on this blog.

"So what are the rules of the game today? If there are any rules to speak of, they are mainly local. Most central banks target domestic inflation and let their currencies float, or follow policies consistent with managed or fixed exchange rates in line with domestic policy goals. Most central banks interpret their mandate exclusively in domestic terms. Moreover, the search for a framework that can satisfactorily integrate the links between financial stability and monetary policy is still a work in progress with some way to go."

Here he repeats that the problem is the rules of the game are at the national (local) level and laments that a framework to deal with problems is "still a work in progress with some way to go."

. . . . 

"This policy design does not help us see – much less constrain – the build-up of financial imbalances within and across countries. This, in my view, is a blind spot that is central to this debate. Global finance matters – and the game is undeniably global even if the rules that central banks play by are mostly local!"

I think we can see where this is headed. The lack of global rules of the game are a "blind spot" for the present monetary system.

. . . . . 

"An array of possibilities then presents itself in terms of the depth of international policy cooperation, ranging from extended local rules to new global rules of the game."

Here is the direct suggestion that we may need "new global rules of the game." At this point I will remind readers of Jim Rickards forecast that when the next big financial crisis arrives (because of a blind spot policy makers don't see), the IMF will then step in to preside over a global reset where they will setup new "rules of the game." This illustrates that this is not a term Jim just made up on his own (see comments below).

. . . . . 

"However, even if countries do optimise their own domestic policies with full information, a global optimum cannot be reached when there are externalities and strategic complementarities as in today’s era of global liquidity. This means that we will also need more international cooperation. This could mean taking ad hoc joint action, or perhaps even developing new global rules of the game to help instill additional discipline in national policies."

More of the same. A call for new global rules of the game to "help instill additional discipline in national policies." This clearly means national interests must give way to global interests.


To conclude, the current environment offers us a good opportunity to revisit the various issues regarding the IMFS. Addressing the blind spot in the system will require us to take a global view. We need to better anchor domestic policies by taking financial factors into account. We also need to understand and internalise the international spillovers and interactions of policies. This new approach will pose challenges. We have yet to develop an analytical framework that allows us to properly integrate financial factors – including international spillovers – into monetary policy. And there is work to be done to enhance international cooperation. All these elements together would help establish better global rules of the game.

The global financial crisis has demonstrated that international cooperation in crisis management can be effective. For instance, the establishment of international central bank swap lines can be seen as an example of enlightened self-interest. However, we must also recognise that there are limits to how far and how fast the global safety nets can be extended to mitigate future strains. This puts a premium on crisis prevention. Each country will need to do its part and contribute to making the global financial system more resilient – and I would add here that reinforcing the capacity of the IMF is one element in this regard. And taking international spillovers and financial stability issues into account in setting monetary policy is a useful step in this direction.

The concluding remarks pretty much say it all. Fixing the global blind spot will "require us to take a global view." We need to "establish better global rules of the game." Also, we need to "reinforce the capacity of the IMF" in this process.

This is why we follow IMF and BIS statements and articles here. As we have noted many times, any major global monetary system change we get is going to be led by these two organizations as things stand today. 

The new BRICS bank and AIIB led by China may alter the landscape eventually. But right now, the IMF and the BIS are still the organizations to watch if you are looking for major monetary system change (a change in the "rules of the game") that might impact your life.

This article also illustrates why we continue to follow Jim Rickard's forecast on all this. It fits nearly perfectly with the remarks made by this BIS official as can easily be seen above. Jim has predicted we will get new rules of the game and has talked about that for some time now.

Jim Rickards talking about the "rules of the game"   (April 17, 2014 interview)   

"When I say the new system, we mention those three prior collapses. Each time, it was not the end of the world. People did not go into caves and start eating canned goods and tuna fish. What it meant was that the major financial and trading powers of the time sat down in a conference around a table and rewrote what they call the rules of the game. I love the phrase ‘the rules of the game.’ It’s not mine—that phrase has been around for a hundred years, but it’s shorthand among international monetary experts for the way the international monetary system is organized at a particular point in time. For example, after the 1914 collapse, there was a monetary conference in 1922 in Genoa, Italy, where the major powers of the day rewrote the rules of the game and came up with a new system."

Added note 8-6-15: A full list of systemic risk warnings can be found on this blog page 

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