The international monetary system suffers – in its current form – from several imbalances that reinforce the monetary instability of the global economy, since the collapse of the monetary system emanating from the “Bretton Woods” agreement in 1971 after the declaration of former US President Richard Nixon that the dollar was not convertible into gold, and then the signing of the “Jamaica Agreement” “The year 1976 that officially ended decades of fixed exchange rates among major international currencies, and international monetary relations became synonymous with instability.
Many countries across the world have experienced monetary and financial crises that have given rise to this instability in recent decades. Read also How did the World Trade Organization change China’s economy?How trillions Biden help the global economy?Why is the Corona crisis in India hindering the growth of the global economy? Stratfor: Economic espionage is the weapon of the future in the hands of totalitarian regimes
In light of the uncontrolled globalization and financial openness that the world has known since the adoption of the neoliberal approach in the eighties of the last century; The movement of capital has become more intense and flexible given its liberation from all restrictions that used to protect countries from the massive and sudden exit of international capital, which leads to the collapse of local currencies against international currencies, as happened during the Asian financial crisis in 1997, for example.
This results in massive economic problems such as hyperinflation, the high budget deficit and indebtedness due to the increase in the value of the external debt in local currency, which often imposes on states the option of austerity in government spending as a quick solution, leading to social and political problems.
In order to reduce monetary instability, it was necessary to qualify central banks to intervene in the foreign exchange markets and prevent large fluctuations in exchange rates. This quickly became an urgent demand and a great bet for many countries, especially developing ones.
That is why it is compelled to accumulate significant foreign exchange reserves, so that central banks can intervene in the exchange market whenever needed and necessary, by increasing the supply of international currencies and reducing pressure on the local currency, thus preventing the latter from collapsing or declining to Levels that inevitably lead to importing inflation.
Accumulation of foreign exchange
Since the eighties of the last century, the world has witnessed a frantic race towards the accumulation of foreign exchange reserves at an accelerating and slowing pace according to the years, as these reserves in the world reached more than 13 trillion dollars in 2020, while they did not exceed 410 billion dollars in 1980, which represents the US dollar. Always more than half of these reserves.
This dynamic has led to two basic results that have left the economies of developing countries in a trap from which they have not been able to escape until now, namely: First: Adopting an economic and development model directed towards exports, and dependence on foreign markets in order to obtain foreign exchange.
On the other hand, neglecting domestic demand and the needs of the local market and mortgaging the national economy to the capabilities of other countries to secure essential and strategic commodities (especially food) instead of seeking self-sufficiency from them.
Secondly: The necessity of investing these reserves in assets with large liquidity and zero risks in order to ensure their liquidation (transferring them to the monetary situation) quickly when needed, but their returns are low or almost non-existent sometimes, and thus the opportunity to invest these funds in productive projects that generate greater profits is lost, or In financing infrastructure projects that enhance the country’s ability to attract foreign direct investment.
The well-known economist Dani Rodrik has previously indicated – in a serious econometric study – the high social cost incurred by developing countries from the need to accumulate foreign exchange reserves.
This social cost is represented in the difference between the proceeds from the possession of foreign assets (US Treasury bonds, for example) and the possible profit for example by investing in local assets and in the national economy in general. Rodrik explained that this cost reaches almost a percentage point of the output Gross domestic product for developing countries combined, and may reach several percentage points for some countries.
Other prominent economists such as Joseph Stiglitz – a Nobel Prize winner in economics – have shed light on this reality by noting that accumulating US dollar reserves necessarily means lending to the United States at low interest rates.
Conversely, US investors in emerging markets and some developing countries (whether investing in government sovereign debt or owning corporate stocks) are getting higher returns thanks to higher interest rates and growth rates in these countries.
What increases the social cost that we have already mentioned is the inflation resulting from the rise in the prices of primary materials and basic commodities globally, which leads to the erosion of the value of these reserves, as the real returns after deducting the inflation rate are a negative number.
China has been aware of this trap for years, which led it to make a major and qualitative change in the level of its investment strategy, and to direct investment in real and real assets and in productive projects directed towards the internal market.
China has invested billions of dollars in recent years in deals to acquire rights to exploit mineral mines and oil and gas fields in many countries around the world.
It has also acquired long-term exploitation rights for vast areas of agricultural land and forests, in order to secure their supplies of basic commodities and energy and food resources, as well as investing in thousands of companies in the United States, the European Union and other economies, in addition to lending to many governments in developing countries. In exchange for deals to complete infrastructure projects.
On the other hand, China invests in major projects that enable bringing modern technologies from abroad and indigenizing them (renewable energies and communication systems as an example). In order to advance at the level of the value chain, and specialize in the future in high-value-added products instead of the cheap labor-intensive products that China is currently producing for the world, and what confirms this new trend is the rise in the level of wages in Chinese cities in recent years, and confirming The ruling party in China stressed the importance of moving towards technological sectors in its new plan.
But it should be recognized, of course, that China’s huge reserves allow it this large margin of movement, and it is at the same time that it enables it to acquire enough foreign currencies to defend the yuan’s exchange rate at the targeted levels, and to invest the rest of its reserves in assets and projects that generate greater profits.
This is not the case for all developing countries, a large part of which remains at the mercy of cross-border capital, and victims of an unfair international monetary system that first serves the interests of the United States, the key currency owner in this system.