T he Bank of Japan began an operation in mid-September to supply U.S. dollars to institutions participating in the Tokyo money market, including foreign banks and brokerage houses. This operation, part of a joint effort by central banks around the world to fight the credit crunch that followed the collapse of the U.S. housing market, was made imperative by the fact that interbank lending of dollars — a basic component of the financial system — broke down.
As globalization accelerates the cross-border movement of goods, money and resources, the need for a coordinated operation of this type suggests that the Federal Reserve Board — the central bank of the United States — has become unable to perform one of its main functions: supplying dollars.
Central banks are responsible for supplying their own currencies and being lenders of last resort. On the other hand, the job of supervising banks, including their overseas branches and other units, rests with the financial authorities of the home countries.
The current situation suggests that this division-of-labor arrangement is starting to crumble.
Given that there is no global central bank, the FRB is supposed to be responsible for supplying dollars, the European Central Bank for supplying euros, and the BOJ for yen. But the credit crunch that is playing havoc with financial markets worldwide suggests that the FRB is failing to fulfill this crucial function, forcing it to rely on central banks in other countries to supply dollars to the European and Japanese markets.
This decline in the FRB’s ability stems from the fact that the U.S. government allowed itself to maintain an external deficit for such a long time, and the fact that other governments continued to take advantage of the convenience of using dollars.
Governments have made little progress on building a global monetary control mechanism capable of responding to globalization, and they have also left fiscal control and financial supervision in the hands of each separate country. This has created a disconnect between real economic conditions and the global financial system.
The euro zone is no exception, despite its unified currency and the establishment of the ECB. Even though the ECB has responsibility for setting monetary policy for the euro zone, the supervision of banks was left, again, in the hands of each government. In this sense, Prime Minister Taro Aso appears to have made a rational move in appointing Shoichi Nakagawa to serve concurrently as both the finance and financial services ministers.
When the U.S. economy began weakening, some people asserted that a “decoupling” of certain economies would take place. Their argument was that even if the U.S. economy were to decline, Europe and the BRIC countries would take up the slack and sustain global growth. This belief appeared to be particularly strong in Japan, which had few fiscal or monetary options at its disposal to deal with the budding crisis.
But what has actually taken place since then is integrated global stagflation. The economic problems of the world have synchronized with each other rather than decoupled. That the plunge in share prices is taking place not just in North America, Europe and Japan, but in China and Russia as well is proof that mutual dependency around the world has deepened.
The subprime-mortgage loan problem emerged from the rapid growth of excess liquidity and a bubble in the U.S. housing market that never seemed like it would end. But the excess liquidity quickly dried up and caused a credit crunch, even though some money supply indicators around the world have moved upward since the housing bubble imploded. This is because the collapse of various banks and companies has shredded mutual trust. And part of the blame for that lies in the decline of the currency management capabilities of the FRB.
The postwar global financial regime led by the International Monetary Fund was based on an adjustable system of fixed exchange rates centered on the U.S. dollar. This system has been left unattended since 1973, after the world shifted to a floating exchange-rate mechanism. The yen’s exchange rate against the dollar is now around 100 — less than a third of the 360 it took to buy a dollar back then.
Given that no global currency has emerged to take the place of the U.S. dollar, the world is being pressed to rebuild a financial system that can accommodate today’s economic realities. While greater coordination by the major economies will have to be the solution for the time being, it is essential to recognize the underlying changes taking place behind the scenes of this crisis.
Teruhiko Mano is a professor at Seigakuin University Graduate School.