Moving geopolitical tectonic plates

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A more fragmented world will need the IMF more, not less

The Russian invasion of Ukraine has opened a new chapter in international relations, with important implications for the world economic order.

The outbreak of full-scale war on European soil, with its associated human tragedies, brings back memories of the continent’s darkest times. Within three days of the invasion, the Group of Seven, consisting of Canada, France, Germany, Italy, Japan, the United Kingdom and the United States, soon followed by other countries, deployed a series of economic sanctions against the aggressor.

As noted in our latest World Economic Outlook, the war and associated economic sanctions will have a major impact on the global economy, slowing activity and increasing price pressures.

Like an earthquake, the war has an epicenter, located in Russia and Ukraine. The economic record of these two countries is extremely heavy. According to our projections, the Ukrainian economy will contract by 35% and that of Russia by 8.5% in 2022.

The war also caused seismic waves, radiating from the epicenter, and impacting economies everywhere. The first impact is on the price of raw materials. Because Russia and Ukraine are major producers and exporters of oil, gas, metals and grains, the price of these commodities has skyrocketed, causing hardship around the world and contributing to a significant increase in inflation. Secondly, trade flows have been severely disrupted, with a major impact on Russia’s and Ukraine’s close trading partners, particularly in the Caucasus, Central Asia, Eastern Europe and the Baltics, but also more largely through supply chain disruptions. The war has also caused a major refugee crisis in Europe, with nearly 6 million people fleeing Ukraine in less than three months. Third, the war caused financial conditions to tighten, weakening many economies and indirectly tightening monetary policy faster than expected in advanced economies.

The earthquake analogy is perhaps the most appropriate because war reveals a sudden change in the underlying “geopolitical tectonic plates”. The danger is that these plates will move further apart, fragmenting the global economy into separate economic blocs with different ideologies, political systems, technological standards, cross-border payment and trade systems, and reserve currencies. The war has made manifest deeper divergent processes. We must focus on these and understand them if we are to prevent the ultimate collapse of our global economic order.

In this regard, the earthquake analogy has its limitations, which gives reason for moderate optimism. These “geopolitical plates” are man-made and reflect history, institutions and people. While each plate or block may have enormous inertia, ultimately people – and their governments – can chart their own course. Reason and mutual economic interest may prevail.

In this context, the most profound economic force at play is the rise of emerging market economies, particularly China. The economic rise of China and other emerging market economies is a direct consequence of their integration into the global economy: international trade and economic growth have surged over the past 40 years precisely because the world was not segmented. Yet the rise in economic power of these countries has not been matched by a similar increase in their global financial and institutional firepower.

Nowhere is this more evident than when we examine the importance of the US dollar in the international monetary and financial system. System scholars like me have long pointed out that US dollar dominance is absolute and organic but ultimately fragile. It is absolute because no other international currency manages to question the role of the dollar as an international means of payment, unit of account and store of value. It is organic because this domination does not depend on organized rules. Dollar-gold convertibility ended in 1971, yet the dollar’s dominance has instead increased due to interlocking, self-reinforcing network effects, and the unchallenged liquidity and security of US Treasuries. It is also ultimately fragile because the United States’ share of global output, and therefore the share of global output that it can safely back up through its official debt instruments, is bound to decline. as emerging market economies develop. With a declining share of global output, the United States cannot remain the world’s sole provider of safe assets indefinitely. This is what Hélène Rey and I have called “Triffin’s new dilemma”.

No one can reasonably predict when or how the current absolute dominance of the dollar will be supplanted by a multipolar system. This is one of the flaws in the current economic order. How this transition is implemented could have a major effect on the global economy and the future of multilateralism. At one end of the spectrum, we might end up with separate blocks. This would solve Triffin’s dilemma by making the world smaller, but also less efficient. On the other hand, the global economic system could remain integrated, but the interactions and possible coordination between several reserve currencies, including the US dollar, remain undefined.

In this vacuum, the war and the unprecedented and coordinated freezing of the international reserves of the Central Bank of Russia represent major new developments. Powerful centrifugal forces have been set in motion which, if not carefully controlled, could lead to further economic fragmentation.

By design, the central bank reserve freeze represents a major attack on the heart of “Fortress Russia,” the economic and financial bulwarks that Russian authorities have put in place since the 2014 invasion of Crimea. large war chest of international reserves… 37% of Russian GDP – was supposed to protect Russia from financial sanctions. With much of the reserves frozen, Russia now relies heavily on continued energy exports to fund its war effort – a major vulnerability.

But central bank sanctions call into question the broader usefulness of international dollar reserves in the first place, especially if the terms under which restrictions on their use appear arbitrary, at least from the perspective of the countries that hold them. This poses a “Triffin geopolitical dilemma” where the expectation of future restrictions on the use of reserves, instead of insufficient fiscal space, could trigger a move away from dollar assets.

In this regard, the war has highlighted the potential instability of the current global economic order. In this new environment, the IMF faces serious existential questions. As a global institution whose goal is to promote global economic integration, it can become increasingly difficult to operate in a geopolitically polarized environment. The convenience route would be to scale back ambitions and focus on the bloc historically aligned with early Bretton Woods signatories. But that would not be up to the historical challenge.

The war highlighted the potential instability of the current global economic order.

Instead, we must recognize that a fragmented world is a more unstable and vulnerable world, where access to safe assets is more restricted and the global financial safety net is less complete. This is a world that needs the IMF more, not less. As an institution, we must find ways to fulfill our mission to provide financial assistance and expertise when needed and to maintain and represent all of our members, even if the political environment makes it more difficult. If the geopolitical tectonic plates begin to pull apart, we will need more bridges, not fewer.

PIERRE-OLIVIER GOURINCHAS is an economic adviser to the IMF and director of the research department.

Opinions expressed in articles and other materials are those of the authors; they do not necessarily reflect IMF policy.

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