A Critical Analysis: Why the Global Reserve System Needs Reformation

This essay critically examines the arguments presented in Jose Antonio Ocampo's article, "Why Should The Global Reserve System Be Reformed?" The analysis focuses on the inherent flaws within the current dollar-based global reserve system, including its deflationary pressures, reliance on the U.S. dollar, and growing inequity bias. Ocampo's proposals for reform, such as transitioning to a multi-currency system or adopting an SDR-based global reserve system, are evaluated. The essay further explores the historical context of the SDR, its limitations, and potential for future development, while also addressing criticisms and contributions to the discourse on global financial stability. The author concludes that reforming the global reserve system is crucial for addressing global imbalances and promoting sustained economic prosperity, emphasizing the need for international cooperation to overcome political obstacles and ensure equitable benefits for all nations. Desklib offers a wide array of solved assignments and study resources for students.

Running head: DIALOGUE ON GLOBALIZATION
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Why Should The Global Reserve System Be Reformed?
7/11/2018

DIALOGUE ON GLOBALIZATION 1
Why Should The Global Reserve System Be Reformed?
Introduction
Why Should The Global Reserve System Be Reformed? is an article published in
Globalization and development Journal in the January 2010 issue. Jose Antonio Ocampo
writes this article. The writer of the article focuses on the dollar reserve system that is the
main root cause of the problem and reforms the fundamental flaws of the system. The biggest
concern is the International Monetary system, which is heating up in recent years. Prior to the
current crises, consideration was centered on the huge global imbalances that the world
economy had aggregated, as well as on the rationale of foreign exchange reserves by
developing nations.
It is promoting the fact that the global central currency, which is U.S. dollar, should be
reformed because the Central currency tends to be stable, equitable and dominant. The
framework additionally adds to the payments imbalances, on the other hand inflationary or
recessionary pressures on the world economy.
In the following an effort has been made to point out main arguments of the article stated as
needs of the global reserve system, Flaws of the current system, reforming the system, Multi-
currency system, SDR based Global reserve system and Transitional arrangements.
Article Summary
In this article the economic crises has contributed in regards to the generation of global
reserve system. Since the start of the century, the dollar has no longer seemed like a
significant worth; its value has been unstable and apparently subject to decline. However, the
crises has undermined trust in the U.S economy and its administration, and hence the dollar
as a reserve currency. The magnitude of the continuous world financial breakdown and its
real economic impacts has narrowed the emphasis on international financial issues. A fact
made 50 years back by the Belgian –American economist Robert Triffin. Response of this
major issue was the reason behind Special Drawing Rights (SDRs) was made in the 1960’s
(Stiglitz, Greenwald, 2010)
There are three fundamental flaws, which include-
 Recessionary pressure
 Use of U.S dollar as a global currency
 Growing inequity bias

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The first flaw is deflationary predisposition of any system in which burden falls on deficiency
nations. It preceded the formation of the Bretton Woods institutions, is that the international
monetary system is tilted against deficit countries.
This has a tendency to generate a universal deflationary predisposition: the changes those
deficit countries need to implement to adjust their external records when financing is not
accessible in adequate amounts. This system is proposed by Keynes to create a more
systematic framework and allude to this problem as the anti-Keynesian bias.
The second flaw is depends upon two main features: the use of U.S. dollar as the major
reserve asset and soaring demand for” self-protection” that country face.
It is generally referred in the literature as the Triffin di-lemma after pioneering work of
Robert Triffin in 1960s. The main problem they are focusing is to provide sufficient liquidity
and to manage balance of payment crises. The only way for the remaining world is to gather
net dollar assets to run a current account deficit
The third flaw is growing inequity bias that the system is unbalanced, and that such
imbalances have built up as developing nations have gathered huge amounts of foreign
exchange reserves (FER) and U.S treasury bills. It has been expanded in recent decades of
monetary and capital market by firmly pro-cyclical flows that developing countries face.
These facts led to a substantial accumulation of foreign exchange reserves as
“self-protection “or, “self-security.” This means the traditional “precautionary” or
“defensive” demand against financial crises.
The author has recommended three alternatives to reform the current system –
 Inertial result is to grow into a multi-currency course of action.
 Slowly move to global reserve asset.
 Creation of new institution.
They has also suggested implementing a Multi-currency system, SDR based global reserve
system and Complimentary reforms. Multi-currency system represents around 66% of global
foreign exchange reserves over the present decade. The basic advantage is that provide
developing countries, the advantage of broadening their foreign reserves. SDR is the virtual
currency of IMF and some other international organization. It is possible claim on the

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monetary forms of IMF members. SDR can be traded for these currencies. Its role is to
provide liquidity and supplement member countries foreign reserves (S, 2018).
Critical analysis of Article
The article “why should the Global Reserve System is reformed”? Gives a detailed
discussion on the issues of global reserve system that seems inequitable and contributes to
volatile global economy. Ocampo contend that the global reserve system indicates
fundamental flaws of the current system. Instead, it also encounters SDR, which also provide
potential claim to IMF members and creates a network of regional reserve funds. It highlights
high level of instability and global imbalances. The author argues that Global reserve system
stated fundamental flaws of the current system-
Firstly, Keynes highlighted in his proposal for a global system established at Bretton Woods,
the worldwide monetary system has been based on the fiduciary U.S dollar as means of
payment determined in dollars as the significant part of FER. It makes a recessionary
pressure on the world economy. That issue is perceived through specific seriousness during
global recessions. As the author contends, the global reserve system is both inequitable as
well as insecure. With every previous framework, it lacks mechanism to offset the balance of
payments, and shortfall of various economies. It will indicate to these effects as the
worldwide “deflationary “on world economic activity.
Surplus countries may also confront pressures, especially those related with the domestic
inflationary impacts that balance of payment surpluses reproduce. This inclination is
particularly tough amid global crises when there is absence of adequate financing powers is
there.
Next problem is that created by use of U.S. dollar as the significant international currency.
Robert Triffin emphasized the basic issue: an international reserve system, which is based on
national currency, is naturally insecure. The major issue at that time the country was facing is
the transformation of dollar reserves into gold. However, the U.S moves forward to correct its
shortfall to minimize a loss in gold reserves. After failing to manage the misfortune through
Gold Pool, U.S. took a decision to abandon convertibility of dollar for gold in 1971. This will
bring a huge changed in the nature of Triffin dilemma.

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Third issue is the growing inequalities created by the necessity that developing nations face to
associate FER to control the pro-cyclical studies. This phenomenon of inequity bias turned
out to be visible in 1990s. They contribute to the creation of global imbalances. The author
argues that international reserves are important for financially open economies to counter the
encouragements to transform balance of payment into foreign exchange. Rodrik argues that
foreign reserve is clearly expensive as they have low-yields and are associated with
sterilizing its financial impacts.
One attempt of this case can also be moving to a Special Drawing right (SDR). SDR is made
as an international reserve in the context of Bretton woods fixed exchange rate system in
1969. The downfall of this system is in 1973 and the move of major currencies to exchange
rate decreased the dependence on the SDR as a global reserve. It assists as the unit of account
of the IMF. It is currently manufacturing unit of value that might be exchanged by a holder to
other International monetary Fund members (Money matters, 2018)
IMF argues that SDR provided by IMF to its individuals is based on their membership quota.
As the shares of developing nations are higher, the significant portion is accessible to them.
Thus, the IMF limits the borrowing capacity of less developed nations. It provides inequitable
distribution of development finance. They get through from various problems such as BOP
deficits, debt burden, internal inflation, and constrained access to private banking, fluctuation
in export earning etc., have expanded the need for liquidity with respect to developing
countries. So, it becomes important to create more SDR for less developing nations. The
author criticized that SDR was put into force when the U.S. dollar was under devaluation. It
did not deal with liquidity operations and financial compliance for fewer developing
countries. This scheme was proposed to safeguard just the dollar crises.
SDR subsequently denotes a major step in managing international monetary system on a
rationale framework, while staying within the reasonable framework of the international gold
exchange as implemented by the IMF. Another Criticism of SDR is that the present Ordinary
Drawing Right in the IMF which gives hike to a temporary increment in international
liquidity, they are proposed to make a durable addition to it. Thus, SDR is much in favor of
U.S.A. but significantly disadvantages to the rest of the world and particularly to the poor
nations. Critics feel that it should have been sanctioned only when value is kept in equality in

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the international market. Therefore, if it has been utilized effectively and efficiently then it
will be beneficial for unprivileged countries (Obstfeld, 2011)
Contribution
The world’s financial system is growing through a lot of instability and inequity bias in
recent times. The perception of free-market that a development to flexible exchange rates by
financial market liberalization would consequently be manages risk and sustains high growth.
As seen above various flaws and deficiencies of the current system, there is need for a global
reserve system to sustained prosperity and stability. Reform of the global reserve system is
crucial to deal effectively and efficiently with global imbalance. The most desirable reform of
this system includes moving to a multi-currency system and SDR based IMF with a
reasonable core interest (IMF, 2018)
It may be concluded with certain crucial changes and improvements in SDR scheme, it is
hoped that it will be successfully and efficiently managed and executed to solve the basic
issues associated with the financial disequilibrium in the world. Indeed, even with such
reforms there are probably going to be substantial increment in reserve holdings and the
global economy also become stronger. The SDR would be more powerful if it could be
exchanged directly for reserve currencies with the central bank for the rapid creation of
outside liquidity.
Despite the fact that a change is reasonable, numerous political hindrances must be
overcomes. The utmost important concern is the fear produced in the U.S. by the inevitable
harm of the dollar. However, they can also maximize by eluding possible assumption on the
dollar. This demonstrates the current system has given huge costs for the U.S.
Therefore, while political challenges of proposed reform are extensive, they are not
unbeatable, as it maximizes benefits for all nations and maintains growth. For this reason,
reform of the global reserve system ought to be a priority for policy makers in all nations.

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References-
IMF (2018) Special Drawing Right.[online] Available from:
https://www.imf.org/en/About/Factsheets/Sheets/2016/08/01/14/51/Special-Drawing-Right-
SDR [Accessed 12/07/2018]
Money matters (2018) Special Drawing Rights (SDR) | Definition | Uses | Criticism. [Online]
Available from:https://accountlearning.com/special-drawing-rights-sdr-definition-uses-
criticism/[Accessed 12/07/2018]
Obstfeld,M. (2011) The SDR as an International Reserve Asset: WhatFuture.[online]
Available from: https://www.theigc.org/wp-content/uploads/2014/09/Obstfeld-2011-
Working-Paper.pdf [Accessed 12/07/2018]
S,N. (2018) Critical Appraisal of Special Drawing Rights Policy of IMF.[online] Available
from:http://www.preservearticles.com/2012020222414/critical-appraisal-of-special-drawing-
rights-policy-of-imf.html [Accessed 12/07/2018]
Stiglitz,J.,Greenwald,B. (2010 ) Towards a new global reserve system.Journal of
Globalization and Development.1(2).