In addition, there is no clear evidence that China’s exchange rate was, or is, undervalued vis-à-vis Europe or the United States relative to their ‘real’ multilateral exchange rates averaged over the past 20 years.

Not finding any agreement on exchange rate practices, the G20 meetings shifted to trade imbalances. Last November, the United States suggested that countries with trade surpluses cap them at, say, 4 per cent of GDP. But trade surpluses simply reflect net saving surpluses: the difference between national saving and investment. And in market economies, governments don’t directly control either. Nor, contrary to popular opinion and that of ‘China bashers’ who are calling for China to appreciate the RMB, can exchange appreciation be used as an instrument to reduce any creditor country’s saving.

Yet in light of the November impasse of the G20 and continuing stalemate in 2011 on exchange rate and US fiscal issues, it is clear that movement on these issues will be a long time coming.

With exchange rates and trade balances off the table for now, what remains for constructive international monetary reform? Almost all emerging market economies at the G20 meeting in November 2010, and even more now in 2011, complain about ultra-low interest rates at the ‘centre’ inducing hot money flows to the ‘periphery’. In addition, the US Federal Reserve’s ‘Quantitative Easing’ for reducing long rates (ending in June 2011) exacerbated the problem. In 2010-2011, the resulting ‘carry trade’ has induced a flood of hot money into emerging markets — which have higher growth and naturally higher interest rates.

The combination of very low American interest rates and a declining dollar have provoked large outflows of financial capital (‘hot’ money) into emerging markets for almost a decade. When emerging market exchange rates are not tied down by official parities, their ongoing appreciation induces even more hot money inflows. Speculators see a double benefit: the higher emerging market interest rates combined with their currencies appreciating against the dollar or yen.

For emerging markets exchange rate flexibility is no protection from foreign interest rate disturbances. In the short run, exchange rate flexibility may actually enhance the returns that carry traders see as the target emerging market currency appreciates against the dollar.  To slow the appreciations of emerging market currencies, central banks typically intervene to buy dollars with domestic base money.  And these interventions have been truly massive. From the first quarter of 2001 to the first quarter of 2011, the dollar value of emerging market foreign exchange reserves rose six fold, with — from $1 trillion to $6 trillion! China accounted for about half of this huge buildup.

This sharp buildup of emerging market foreign exchange reserves has been too big to fully offset by domestic monetary sterilization operations. The resulting loss of monetary control in the emerging market economies led (and leads) to inflation generally higher than that in the developed market economies. On a world scale, the most striking inflationary impulse is seen in primary commodity prices. Year-over-year to 21 June 2011, the Economist’s dollar commodity price index for all items shows an average increase of 38.6 per cent, with food prices alone rising 39 per cent.

Near-zero interest rates in the mature industrial countries contribute to commodity price inflation in two ways. First, they generate hot money inflows into the emerging market economies and emerging market demand for primary commodities rises.  Secondly, once commodity prices begin to rise, ‘commodity’ carry traders find they can borrow ultra cheaply in New York or Tokyo to fund long positions in commodity futures. Of course, this adds to the upward price momentum making commodity prices, and asset prices in general, more prone to bubbles.

What are the implications for international monetary reform? In the new millennium, world monetary instability has been (and is) provoked by large and persistent interest differentials that induce ‘carry trades’: the willingness of speculators to borrow in low- interest- rate currencies (source currencies) to invest in higher yield currencies (investment currencies). But what can governments do about this?

Central bankers from the G20 could meet continually to monitor each other in order to prevent wide interest differentials from developing. True to its newly professed virtue, the IMF should refrain from criticizing countries who attempt to impose capital controls to stem hot money flows. It could also provide technical advice on how to do so most efficiently.

To better preserve financial and exchange rate stability in the transition, the big four central banks — Fed, ECB, Bank of England, and Bank of Japan — should move jointly and smoothly to phase in a common target minimum target — say 2 per cent — for their basic short-term interbank rates. By escaping from liquidity traps which so impair the efficiency of domestic bank intermediation, and lessening the bubbles problem, the mature economies would benefit along with the emerging market economies.

Reducing the spread in interest rates would dampen carry trades and hot money flows in an important way. But it may not be sufficient to end them altogether. So acknowledging the legitimacy of emerging markets using capital controls and other devices to dampen hot money inflows should be an important part of the new G20 discussion. Indeed central banks in the mature industrial economies could monitor their own commercial banks to help central banks in emerging markets enforce their controls.

But there is an important asymmetry here. Capital controls are not for everybody. In particular, the United States at the centre of the world dollar standard cannot itself impose capital controls without destroying the world’s system for clearing international payments multilaterally. Thus everybody has a vested interest in rehabilitating the unloved dollar standard with open US financial markets. The first of many necessary steps in the rehabilitation process is for the Fed to abandon any thought of a QE3 while phasing out its policy of keeping short rates near zero.

Ronald I McKinnon is the William D Eberle Professor of International Economics at Stanford University.