The Role of US and EU Financial Markets in the Global Economy - Essay Example

USA and it currency the US dollar has been the choice of reserve currency the world over for several decades now. There have been talks of fall of supremacy of US dollar a number of times but no one took them seriously and US dollar continued to reign supreme. The collapse of US housing bubble and once again brought the pessimists out in the open and they are predicting collapse/ crash of US political and economic domination. In a small measure growth and stability of Euro has given the central banks an alternative to the dollar. The financial markets went into a tailspin recently when it was rumored that Kingdom of Saudi Arabia was looking at alternative to dollar for pegging its currency. Iran has tried unsuccessfully to exhort OPEC countries look for alternatives to dollar, but has announced that it would diversify its foreign reserve portfolio to include Euro as well. It will not create much dent in US armor yet it has strong political message for USA. Malaysia has also tried to establish gold dinar for settling bilateral trade with Iran. Experts feel that it would not be as widespread as these two countries hope as gold would be too cumbersome to be traded and exchanged. Similarly some South American countries are also trying to establish alternatives to IMF and World Bank to cut the dependence on USA and its interfering policies as they see them. They are all small steps yet they show that countries are looking at alternatives to the US dollar. US dollar is not the most preferred currency with the common man too; there are reports that now a days people prefer to be paid in their local currencies by foreigners rather than dollars for the fear of devaluation of dollar something unimaginable a couple of years ago. This shows that the confidence on dollar cross the globe is ebbing slowly but surely. Jean-Claude Trichet President ECB has as far back as 2005 called for structural changes in the international financial system to take care of financial crisis which calls for greater financial transparency, more systematic approach to the future growth and greater global ownership. Apart from these three measures, inclusiveness of emerging economies and economies in transition in international financial architecture and greater cooperation of central banks of emerging economies and economies in transition would help in systematic development and correction of financial system. This shows that not only Europe and Japan have are going to have greater say in international financial system but emerging economies like BRIC and other South East Asian counties too will need to be included. A significant departure from the fact that USA called the shots after the downfall of USSR and end of cold war. USA is grappling with huge current account deficit, Japan as current account surplus where as Europe is balanced. Erosion of value of dollar and erosion of political supremacy of USA is linked together. It is time now for USA to share the burden of dollar with Europe. Edwin M Truman (2007) in his speech has said, "The United States and Europe have huge stakes and responsibilities in the stability of the international economy and financial system. How their authorities manage their economies and develop their financial systems is key. The challenge is to promote healthy, and to minimize unhealthy, competition between the euro and the dollar and their associated financial systems and economies." He calls for climb down of US and European claim to ownership on IMF and World Bank and include emerging and developing countries in the position of management rather than recipients. He even calls for changing the voting pattern to give greater weight age to other countries of the world to reflect their growing economic stature. The "advanced" countries would need to give up their share by at least 10 basis points and might call for increase in the fund size by 50 percent. This would mean acknowledging the political and economic advancement of the so called developing nations by USA and its allies. There are reports that Saudi Arabian economy is facing inflation due to pegging of its currency to US dollar. A report in the Telegraph (09/21/2007)states that Fears of dollar collapse as Saudis take fright. Saudi Arabia has refused to cut interest rates in lockstep with the US Federal Reserve for the first time, signaling that the oil-rich Gulf kingdom is preparing to break the dollar currency peg in a move that risks setting off a stampede out of the dollar across the Middle East. The paper states that the global investors will start to shun the US bond markets, which is already showing net sales. As the yield gap narrows between US and the other countries, foreign funds would halt and it would be difficult for it to cover its current account deficit. Unlike 1998 Asian crisis, USA economy was in better shape, now it is the problem and there is potential of reverse carry trade to Japan. To ensure that this transfer and sharing of economic burden between USA and the rest of the economic powers (both established and emerging) following legal framework would need to be in place: Transparency - Traditionally US has the best disclosure policies, even Japan and German laws are seen as lax when compared to US. It would foster atmosphere of trust and better comparability and convergence. For this common laws and disclosure norms have to be agreed upon. Sound Financial Systems- The financial systems have to be robust enough to be able to withstand the cyclical ups and downs of the global economy and not be biased locally as is still prevalent in many emerging economies. Private sector participation- Governments alone cannot drive the integration ultimately the success or failure of the alternative will depend upon its acceptance by the private sector. Liberalization of capital flows- Many developing and emerging countries still have a long way to go in this direction, their political and domestic compulsions have not cleared the way towards this completely. Modernization of international markets- this again calls for acceptance of common standards and transparency. Politically it is very fashionable to denounce USA and many countries have been doing it at every opportunity, yet till all the legal framework is not in place, it would be very difficult to arrive at a sustainable alternative to US to share the burden of supporting dollar, till the all attempts will remain regional with regional compulsions and would collapse for this reason. 1. The Role of US and EU Financial Markets in the Global Economy by Edwin M. Truman, Peterson Institute April 17, 2007 Speech by Jean-Claude Trichet, President of the ECB Bundesbank Lecture, Berlin, 21 June 2005 http://www.telegraph.co.uk/money/main.jhtmlxml=/money/2007/09/19/bcnsaudi119.xml Read More