Jean-Claude Trichet: Reflections on the international financial
architecture
Keynote address by Mr Jean-Claude Trichet, President of the European Central Bank, at the
2007 Salzburg Seminar "Challenges to the International Monetary System: Rebalancing
currencies, institutions, and rules", Salzburg, 29 September 2007.
* * *
I. Introduction:
Ladies and gentlemen, it is a great pleasure to be here at Schloss Leopoldsbrunn in
Salzburg. Both the Schloss and the city are places with a lot of history and famous
inhabitants! I am sure that this wonderful location will inspire your work over the coming
days. The Salzburg Seminars have long been a forum for discussion of global issues and the
focus of this particular seminar promises very interesting exchanges of views on very topical
issues. As you know, Salzburg traditionally has been a facilitator of cultural exchanges
across European countries and beyond since the 18th century. I am afraid that by its very
nature, my talk tonight might be less "entertaining" than most other events taking place here
in this wonderful city.
I would like to offer some reflections on the various changes in the set up of the global
economic and financial system. Over the last two decades the international community has
been confronted with tremendous challenges arising from important structural changes in the
global system linked to technological advances and trade and financial integration. During
this period the international community has learnt critical lessons and has launched profound
adjustments to what has been termed the international financial architecture that is the
network of institutions and fora with varying degrees of coordination at the global or
sometimes regional level.
As in other parts of life, the most radical changes to structures and to behaviour are often
launched during or after times of crisis. This has also been the case at the global level. The
Asian crisis, which started exactly 10 years ago, is one case in point. The crisis that began in
summer of 1997 with the fall of the Thai baht - and by the end of 1997 had engulfed
Indonesia, Korea, Malaysia and the Philippines with spill over effects felt in Singapore and
Hong Kong - did not remain confined to emerging markets but affected the global system.
Remember that by August 1998, we had the Russian default, followed by the LTCM crisis in
September the same year.
I do not want to enter into a discussion of the Asian crisis tonight. It is clear, this crisis was
not the first one - we had to deal with the debt crisis in the 1980s and witnessed in 1994/5
how Tesobonos in Mexico developed from a local phenomenon into an issue for the
international community. And it was certainly not the last one; the global system had to digest
crises in Turkey and Argentina as well as shocks in the private sector such the stock
exchange fall and the bursting of the technology bubble in 2000. But it was the Asian crisis
that revealed a number of vulnerabilities in national and international financial systems and
that led to an enormous reform agenda at the international level.
All these crisis episodes that we were confronted with brought to the fore new insights and
lessons. They illustrated forcefully the challenges linked to a more globalised world and the
increasing importance of private capital flows. I would like to highlight two more general
lessons which have remained still important today:
First, one about the interlinkages between countries and the implications for the institutional
set up. The world has changed dramatically over the past decades. The steady opening up
of goods and capital markets has led to the growing integration of countries around the
globe. Integration is of course a welcome development in itself because more and more
countries participate in the global exchange of goods and services and can benefit from the
transfer of know how and technologies. As proven by the experience of many economies,
including in the EU, trade openness is the best catching up strategy for developing countries.
But the contagion effects we have seen from time to time demonstrate the main challenges
associated with interdependence. Globalisation has put all countries around the globe into
one boat. Something that happens in one economy is often not just a local event but can
have implications for the global system. From this fact it follows that all economies which
have a systemic importance should be involved in discussing and participating in the collegial
response of the international community as regards issues of global relevance.
Second, another important lesson from my point of view is the fact that efforts to improve the
resilience of the global international system are not a static matter for which one can claim a
lasting victory at one point in time. The globalisation and catching up process is far from
being completed; likewise, very rapid technological and financial innovations will continue to
be a feature of the modern world for dozens of years to come. Thus, trying to ensure the
public good of global stability is a constant task that requires continuous scrutiny and effort.
Each crisis, or episode of significant market correction, is different from the one before. They
differ in origin, nature and magnitude. Each time new insights are gained about potential root
causes of crises - often painful ones that go beyond simply lax macroeconomic policies and
point to a lack of transparency or appropriate oversight.
These two lessons - that is, the need to involve all important players and to undertake
continuous effort to prevent crises and ensure global stability - are in my view the driving
force of all reform efforts at the international level since the 1990s, be they focused on
frameworks for dialogue and cooperation or on actual policy matters. I will come back to
these two aspects in a short while, but I would first like to highlight some facts which illustrate
the changing global landscape we are living in, and give cause to reflect on the course and
stewardship of the global economy.
II. Changing landscape
There has been a dramatic increase in trade integration over the past two or three decades
that has simultaneously increased opportunities and vulnerabilities. World trade has grown
four-fold in real terms since 1980; its share of world GDP has risen from 36 percent to 55
percent over this period. Part of this impressive development is explained by the integration
of the former communist countries into the global trading system in the 1990s. Also
developing Asia progressively dismantled barriers to trade. Over the past two decades, many
emerging and developing countries have been catching up with advanced economies that
shifted earlier to more open trading regimes.
Likewise, financial globalisation has proceeded at a dizzying pace over the past two
decades. Take the sum of countries' gross external assets and liabilities relative to GDP as a
proxy for financial integration. Since the creation of the euro in 1999 until 2005, total
crossborder financial assets increased from 87 % of GDP to 124 % in the euro area, and from 80
% to 90 % in the US ; international liabilities increased in the euro area from 92 % of GDP to
137% and from 91 % to 110 % of GDP in the US . Advanced economies still continue to be
the most financially integrated. Yet other regions of the world have also increased their cross
border asset and liabilities positions, albeit at a much more moderate pace. These
differences can be explained with different capital control regimes as well as a range of other
factors, including different degrees of institutional quality and domestic financial
development.
But globalisation does not only imply the exchange of final goods, services and capital, but
also outsourcing and off shoring of parts of the production chain. It is probably especially this
aspect of globalisation that often leads to negative perceptions in the general public since it
entails distributional effects among and within countries despite the fact that technological
innovations probably played a more important role in that respect.
One of the most important changes in the global landscape concerns the role of emerging
market economies.1 They have become increasingly significant players on the global scene
and are catching up with advanced countries through continued strong growth. Over the past
five years, these economies grew at about 7% per annum on average; emerging Asia has
been growing faster, at close to 8% per annum. This rapid growth has made emerging
markets the main engine of world growth. Last year China, India and Russia alone accounted
for about one half of global growth (in PPP terms). Likewise, the share of emerging
economies in world exports of goods and services doubled between the early 1990s and
2006, to reach roughly 30%. As mentioned before, their share in financial integration is still
lagging behind advanced economies, but is constantly improving.
What does the present tell us about the future? Will emerging markets overtake those
countries that are currently the major economies in the world? China has already risen from
the 9th largest economy in 1980 to become the second largest (in PPP terms). There are
several studies that try to analyse this question and that deliver interesting results regarding
the growth prospects of emerging markets over the next decades. According to one study,
the so-called BRICs, i.e. Brazil, Russia, India and China, could account for over half the size
of today's six largest economies in 2025 (at market exchange rates), and by 2039 they could
be larger than these countries.2 Similarly, another study concludes that seven emerging
markets will by 2050 be around 25% larger than the current G7 countries when measured at
markets exchange rates, or around 75% larger in PPP terms. This contrasts dramatically with
the situation in 2005 when they were only around 20% the size of the G7 at market exchange
rates and around 75% of its size in PPP terms. According to this study, China will rank
number two on the list of largest economies in 2050 (measured at market exchange rates),
India number three and Brazil number five. Of the current G7 economies, only the US, the
euro area and Japan would remain among the largest economies, the others would be
replaced by emerging market economies.3
Certainly, any projection is subject to a large degree of uncertainty. This holds even more for
projections that try to cover very distant horizons; they are inevitably somewhat speculative.
But such studies might nevertheless provide some indications as to how the global economy
could look like in 30 or 40 years. Even if you do not take their results at face value, the
projections point to a profound rebalancing in the distribution of global output if these
countries make full use of their potential for growth. In any way, they leave no doubt that the
prospects of emerging markets will be critical to how the world economy evolves over the
next decades. The current discussions on the appropriate representation of emerging
markets at the International Monetary Fund show that policy makers do take seriously the
current setting and these future prospects.
Returning to today's world, let us consider the implications of the emergence of these fast
growing countries for the euro area. Growth in emerging markets increases the demand for
those euro area goods and services where the euro area has competitive advantages. And
since the euro area is much more open than other major economies both with respect to
1
There is no single definition of the group of emerging markets. In line with the article entitled "Financial flows
to emerging market economies: changing patterns and recent developments" published in the ECB's Monthly
Bulletin of Janaury 2005, the term emerging markets here is meant to comprise Russia and Turkey in Europe;
Argentina, Brazil, Chile, Colombia, Mexico and Venezuela in Latin America; and China, Hong Kong SAR,
India, Indonesia, Malaysia, Singapore, South Korea, Taiwan and Thailand in Asia.
2
See "Dreaming with BRICs: The path to 2050", Global Economics paper No. 99, Goldman Sachs, 1 October
2003.
3
See John Hawksworth, "The world in 2050 - How big will the major emerging market economies get and how
can the OECD compete?", Price Waterhouse Coopers, March 2006. In a speech on "The new global
economic geography"dated 25 August 2006, Stanley Fischer, Governor of the Bank of Israel, referred to a
study by Angus Maddison, Evidence to the Select Committee on Economic Affairs, House of Lords, February
2005.
BIS Review 108/2007
trade and financial openness the euro area has the potential to take advantage of the new
opportunities. Our exports and imports of goods and services account for around one fifth of
GDP, more than in the US or Japan. And indeed, our trade relations with emerging markets
have strengthened considerably over the time. The share of emerging markets in euro area
trade has grown from about one third in 1999 to more than 40% today. Moreover, the euro
area has become a destination for foreign direct investment (FDI) from emerging markets.
For example, the stock of FDI from the BRIC countries in the euro area tripled in the period
1999-2005 to reach the still modest amount of €12 billion. Conversely, the amount of euro
area FDI in emerging market economies also rose quickly: between 1999 and 2005, the
stock of outward FDI to the BRICs rose by 111% to €133bn.
All in all, we can only benefit from increasing our trade and financial relations with these
countries. While it often entails adjustments to former configurations, one should not forget
that competition from emerging markets strengthens the incentives for structural reforms in
our economies. These reforms have to be undertaken in any case not only to improve
efficiency but also to improve flexibility and resilience in a world where different kind of
shocks can hit an economy.
III. International rules of the game
After this quick snapshot of the changing global landscape I would like to turn now to the
implications for the governance of the global system. It is obvious that the systemic changes
we are observing in the world's economic and financial system require systematic changes in
the policy framework. The rules of the game need to adapt in order to keep pace with
developments. This recognition is not new. It was felt already in the 1970s with the break
down of the Bretton Woods system. And it was felt very strongly in the aftermath of the Asian
crisis ten years ago. At that juncture, the work on improving the international architecture -
which had started with the G7 Ministers and Governors and the summit of industrialised
nations taking place after the Mexican crises in 1995 - was considerably stepped up. This
links me to the two lessons that I outlined at the beginning of this talk, namely the need to
adapt the institutional set up and to involve all important players in a fruitful policy dialogue
and the need for continuous efforts to preserve global stability. One can consider the reform
efforts that have taken place over the years from these two angles. The question is thus what
changes to the international rules of the game have been introduced over time in terms of
format and substance. These two aspects are often interwoven, i.e. institutional changes
often go hand in hand with and are aimed at improving the resilience the global system. Yet I
will try to deal with them one after the other.
Let's first consider the changes in terms of format: With the growing importance of emerging
markets for the global economy - which was felt quite profoundly during and after the Asian
crisis - it became obvious that new ways had to be found to integrate them better into the
international policy dialogue. In response, finance ministers and central bank governors from
22 systemically important countries met in April 1998 to examine issues related to the
functioning of the international financial system.4 This "Group of 22" became in 1999 the
"Group of 20". Since 1999, the G20 has developed into an important international forum for
dialogue and consensus-building among systemically important countries, both industrialised
and emerging. Discussions in the G20 have facilitated consensus on important elements of
the international reform agenda. It has held numerous workshops to deepen the
understanding of issues of global relevance and has engaged in a process of peer reviews to
promote countries' implementation of market-based economic systems. In the early years of
its existence, emphasis was placed on financial stability and crisis prevention, including
issues such as prudent debt management, domestic financial deepening, and exchange rate
regimes. Over time however, the range of topics on the agenda has widened, and now
includes issues such as development, energy, climate change. The G20 has also played a
decisive role in leading by example to promote the wider compliance with standards and
codes in various areas and was instrumental in the process leading to the "Principles for
Stable Capital Flows and Fair Debt Restructuring in Emerging Markets". At present, the G20
is also actively involved in the efforts to reform the IMF and the World Bank, especially in the
current discussions on reforming the IMF's quota and voice system. In my view, it is the
composition and size of the membership that strike a good balance between giving this
informal forum a rather high degree of legitimacy while at the same time also allowing for
frank dialogue between the members.
Frank dialogue is also one of the important aspects of the continued relevance of the G7.
The G7/G8 process is often criticised for no longer reflecting the political and economic
realities of the 21st century. But the meetings of G7 finance ministers and central bank
governors that I have attended over the past 18 years have proven an invaluable forum for
policy cooperation on macroeconomic policies and when appropriate signals given to foreign
exchange markets. G7 countries have also recognised the need to involve emerging markets
in their discussions, and it is now standard practice for finance ministers and governors from
emerging economies - and at times also from developing countries - to be invited to join the
discussions of their G7 colleagues.
A very recent example of a new form of informal cooperation is the Heiligendamm process
that started at the G8 summit this summer. Here again the G8 acknowledged that there can
be no solution to global challenges without active participation of emerging market
economies. At that meeting, along with heads of state and government of Brazil, China,
India, Mexico and South Africa, all countries committed to embark on a high-level dialogue
on a number of global challenges, specifically in the fields of cross-border investment,
research and innovation, energy efficiency, and development.5 Such a process is welcome
because it provides the chance to listen to different views on global challenges, to build a
shared understanding and to develop joint proposals to address these challenges.
Also at the International Monetary Fund there are currently major reform efforts underway in
the context of the medium-term strategy to adjust the institution to a changed environment
and new constellations of players. One of these reforms - the quota and voice reform I
already mentioned - concerns the representation of members in the institution and is thus
considered as crucial for the future governance and the credibility of the Fund. Moreover, the
introduction of multilateral consultations last year constituted a new approach to bring
together countries with a shared responsibility for global issues. The first of these
consultations was dedicated to global imbalances and involved the euro area, the US, Japan,
China and Saudi Arabia. We at the ECB welcomed these discussions as a way to foster the
implementation of the agreed strategy to address global imbalances. More related to
substance than to procedures, let me also mention the recent reform of the Fund's
framework for surveillance, which should help to strengthen this important part of the IMF's
mandate given the current climate of reduced IMF lending.
Before moving on from important changes in the institutional set-up of the international
system, I would like to highlight the Financial Stability Forum (FSF). Its creation back in 1999
was also motivated by the Asian crisis. The FSF is today the only forum which enables
cross-sectoral cooperation among national and international entities in charge of supervision.
Since it includes the major financial centres and holds regular regional meetings involving
countries in the Asia-Pacific region as well as in Latin America, it has a particularly large
reach out to a number of systemically important countries.
Let me turn now to the changes in terms of substance which have been introduced since the
crisis events in the 1990s. Here I have to be selective because initiatives have been
undertaken in many areas to improve countries' macroeconomic and financial sector
institutions and policies and thus their resilience to crisis. The increased focus on financial
sector issues, such as in the framework of the FSF or the changes in progress in the IMF to
place much greater emphasis in surveillance on this matter, is certainly very welcome.
But I would like to highlight three more general concepts which I consider to be of utmost
importance. Firstly, greater transparency, both in the public and private sector, has been one
of the major achievements since the 1990s. Transparency is a precondition for
wellfunctioning markets since it facilitates better risk management and leads to strengthened
market discipline, which in turn has a positive impact on the conduct of macroeconomic and
structural policies. Enhanced transparency also enables investors to better differentiate
between economies and thus helps to counter herding behaviour and contagion effects. The
IMF's special standard for dissemination of economic and financial data has become a
widely recognised benchmark to which a large and increasing number of countries have
subscribed. Transparency in the private sector is also crucial for well-functioning global
financial markets. All in all, I am pleased to note that considerable progress has been
achieved over the years. But there are still areas where there is room for improvements,
including in the reporting to the IMF on the currency composition of countries' foreign
exchange reserves.
My second point relates to standards and codes, which have been internationally agreed for
a wide variety of areas such as macroeconomic and data transparency, banking supervision,
corporate governance, accounting, payment and settlement systems, to name just a few.
The IMF and the FSF have designated twelve of these standards as being of particular
importance for sound and stable economic and financial systems. Such standards distil and
set out what is widely accepted as good practices or guidelines in a given area. Here the
international community had made large strides over the years in the development of new
standards and their implementation as well as in systematically and often publicly examining
countries' compliance. In my view, standard setting and implementation can help to promote
domestic and international stability. The attractiveness of this approach is the fact that is
does not rely solely on rules set and enforced by authorities but also on voluntary standards
adopted by economic agents of the private sector.
My third and last point is linked to the previous one and concerns the fruitful dialogue
between the public and the private sector. Sometimes it might be wise to have principles
voluntarily agreed by the private sector rather than aiming at a heavy-handed public
approach. One prominent example are the "Principles for Stable Capital Flows and Fair Debt
Restructuring in Emerging Markets" I referred to earlier. These Principles have been set up
at a time when the international community was discussing seriously the proposal for an
international sovereign debt restructuring mechanism that was meant to improve the
resolution of financial crises. The Principles are also aiming at this objective but follow a
different route. Debtor countries and private investors agreed on best practices and
guidelines for information-sharing, dialogue and close cooperation both in normal times and
in periods of financial distress. Since I suggested myself such a voluntary code of conduct at
the IMF Annual Meetings in 2002, I am very pleased to see that the Principles are
increasingly becoming an important framework for cooperative actions by debtors and
creditors. These Principles might also set an example for a similar approach adopted in other
areas, such as the hedge fund industry - the highly leveraged institutions and other non
regulated entities - which should develop as actively as possible voluntary benchmarks for
good practices, as also recommended by the Financial Stability Forum for hedge funds.
IV. Concluding remarks
Ladies and gentlemen, over the past two decades we have been witnessing the incredible
transformations of the global economy, such as impressive technological advances, deeper
and wider trade and financial integration, and the emergence of powerful economic giants.
These are all great successes of today's interlinked world. Success, however, does not come
without major challenges and we have been confronted with risks to the global economic and
financial stability more than once over the past 25 years. With each crisis or turbulent
episode we had to cope with, we have learnt numerous lessons. Amongst the most important
ones that are very much common to all of these episodes I will mention four:
First, be as lucid as possible from the outset. It is always a recipe for additional difficulty to
over-assess the gravity of a particular situation and therefore to over-react. But it is equally
dangerous to misjudge a particular situation by underestimating its gravity and the risks that
are at stake. Therefore the quality of the first appreciation, the lucidity of the judgement which
is worked out at the beginning is always of the essence. And for this judgement to be as just
and pertinent as possible my experience is that you need three ingredients: an excellent
analytical preparation, a confrontation of various views within a college of wise persons, and
a great deal of experience within that college. Particularly in those hectic circumstances that
are always complex and multi-dimensional, with a great deal of non-linearities, the textbook
solution might not be of great use. Experience is of the essence.
Second, often the lucidity and pertinence of the judgement - and depending on this
judgement - is the rapidity of action. In the development of a very complex situation a slight
change at the start turns out in very significant discrepancies after a certain period of time
and these significant discrepancies can make all the difference between a situation which
would be under control and a situation clearly out of control. So time is absolutely of the
essence in regaining control of a hectic situation: acting expeditiously is a must.
Third, whatever the nature of the turbulences, which would hit the global financial system, the
multiplicity of entities and parties involved, whether private of public makes it necessary to
agree as much as possible ex-ante on the appropriate ways for handling the situation. From
that standpoint stress-tests are extremely useful. Also useful would be the working out of
voluntary "Principles" stating ex-ante what would be expected from each parties concerned in
a difficult situation. This working out of voluntary principles has already been done, as I have
already mentioned, in the domain of the private financing of emerging economies.
Fourth, and finally, let me mention one constant lesson that we have drawn from all previous
turbulent episodes: to minimise contagion in all compartments of global finance, whether in
the domain of sovereign risks, or in the financial markets of industrialised countries,
transparency appears to be the key principle. In hectic times, when fear dominates, absence
of transparency foster herd behaviour and amplifies considerably the initial shock that
triggered the turbulences. It was one of the main lessons we draw rightly from the Asian
crisis. Transparency vis-à-vis investors and savers, transparency vis-à-vis surveillance
authorities, appears to be the best vaccine against contagion which is at the heart of the
epidemic.
I thank you for your attention.