Special Session RESHAPING THE INTERNATIONAL MONETARY AND FINANCIAL SYSTEMS
Dominant Currencies, Special Drawing Rights and Supernational Bank Money by
Pietro Alessandrini *
Michele Fratianni * **
* MoFiR – Money & Finance Research Group Università Politecnica delle Marche - Ancona ** Indiana University
The Main Points in Brief
• The current financial crisis creates almost a unique opportunity to reshape the IMS by:
– a gradual introduction of a supernational money to reduce the asymmetries of the dominant currency system
• The current dollar-based international monetary system (IMS) is fragile
– the long-run deterioration of the dollar standard – the absence of a coordinated strategy to stabilize the IMS – the inherent weakness in a system that uses a national money (in our case the dollar) as a dominant international money • Monetary authorities face a conflict between domestic objectives of employment and inflation and external objective of a stable money.
Alessandrini & Fratianni Ancona, october 7-2009
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The Main Points in Brief
• China has advocated the revitalization of the Special Drawing Rights (SDRs). • The London G20 meeting has recommended a new allocation of SDRs worth $ 250 billion • But SDRs are a weak scheme that has produced few results in the past
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The Main Points in Brief
• Our preferred solution would be the creation of a supernational bank money (SBM) inspired by the principles underlying Keynes Plan (1943) SBM scheme would:
– operate within the institutional setting of a clearing union – coexist with international currencies ($, Euro, etc..) – offer the opportunity for a coordinated strategy to stabilize the IMS
•
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Dominant Currencies
• The historical evidence indicates that:
– one currency tends to dominate others both as an international medium of exchange and as a store of value – the pattern tends to be more hierarchical than hegemonic:
• in pre-WW I international gold standard, the British pound was at the top the pyramid, with the French franc and the German mark following
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Shares of national currencies in foreign official reserves %
Source: Chimn and Frankel (2005) period 1965-97; IMF, 2008 Annual Report period 2003-07
Year
US$
Deutsche mark
Yen
British poun d 20
4.2 1.6
French franc
Swiss. franc
NL guil der 0
0.5 0.7
Euro
1965
1973 1977
56.1
64.5 79.2
0.1
5.5 9.3
0
0.1 2.2
0.9
0.7 1.1
0
1.1 1.9
Na
Na Na
1982
1987 1992
57.9
53.9 48.9
11.6
13.8 14
4.1
6.8 7.4
1.8
1.9 2.6
1
0.9 2.6
2.3
1.7 0.8
1
1.2 0.7
Na
Na Na
1997 2003
2004 2005 2006
59.1 65.9
65.9 66.9 65.5
13.7 Na
Na Na Na
5.1 3.9
3.8 3.6 3.1
3.3 2.8
3.4 3.6 4.4
1.5 Na
Na Na Na
0.5 0.2
0.2 0.1 0.2
0.5 Na
Na Na Na
Na 25.2
24.8 24.1 25.1
2007
63.9
Na
2.9
4.7
Na
0.2
Na
26.5
6
Alessandrini & Fratianni Ancona, october 7-2009
Dominant Currencies • Today, the system is becoming increasingly bipolar
– the dollar remains at the top of the pyramid – the euro is following, but not quite ready to replace the dollar
• In our proposal a bipolar structure world could be exploited:
– to create a supernational money baked, as a first step, by dollar and euro assets in a clearing mechanism
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The long-run deterioration of the dollar standard
• US adopted a policy of “benign neglect” about external imbalances, benefiting from the “exorbitant privilege” of a key-currency:
• • “interest rate subsidy” on foreign debt asymmetric burden of external adjustment (automatic sterilization of the foreign component of US monetary base)
• US
•
•
operates as a “world venture capitalist” , an evolution of the “world banker” view (Despres, Kindleberger, Salant 1966) is higly leveraged and earns excess returns on assets over liabilities
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The long-run deterioration of the dollar standard
Period
1973-1980 1981-1985 1986-1990 1991-1995 1996-2000 2001-2007
Cumulative surplus (+) or As a percent of US deficits (-), billions of dollars GDP, annual average
4.1 -251.7 -607.4 -367.2 -1,199.6 -4.242.7 0.1 -1.3 -2.4 -1.1 -2.7 -5.1
1973-2007
-6,664.5
-2.1
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Ratio of foreign central bank financing to US Imports
45 40 35 30 25
percentage
20 15 10 5 0 -5 -10 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006
years
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New benign neglect
• The modern “savings glut hypothesis” (Bernanke 2005, 2007) revives the “benign neglect” approach:
–
– – –
Fast-growing Asian countries (mainly China) and oil-producing countries have an ex-ante excess of saving over investment US/industrial countries absorb capital inflows Falling real rates of interest in the world Large imbalances will disappear once the savings shock peters out this interpretation diverts attention deterioration of the dollar standard from the long-run
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Critical question: How long can this system last?
•
•
Bernanke (2005) states that excessive imbalances are bound to last so long as the savings shock persists Bernanke (2007) restates earlier conclusion and speaks of
“the attractiveness of both the US economy overall and the depth, liquidity, and legal safeguard associated with its capital markets” (Bundesbank Lecture, Berlin september 11, 2007 !!..)
•
But he acknowledges that
“the large US current account deficit cannot persists indefinitely” and the rebalancing of external imbalances will require some degree of burden sharing between deficit and surplus countries
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The SDR solution
• The G20 proposal (London meeting, April 2009) of a new SDR allocation worth $250 billion has brought back to front stage the SDR as an international reserve asset Historical record of SDRs is extremely weak :
– – In 1969, original intent of the program was to revitalize dying Bretton Woods: too many dollar liabilities relative to gold After two allocations (1970-72, 1979-81), SDRs have played a marginal role as international reserve
1.
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The SDR structural weaknesses
2.
–
The mechanics of the SDR scheme is limited:
“SDR is neither a currency, nor a claim on the IMF. Rather, it is a potential claim on the freely usable currencies of IMF members” (IMF 2009)
– –
SDRs are issued exogenously without any consideration to countries’ financing needs the scheme operates as a “giro system” (Machlup 1968) aimed at redistributing Central Banks’ reserves only through bilateral transactions:
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The SDR structural weaknesses
3.
–
SDRs do little to solve the IMS fragility problem…..
US share of the new SDR 250 billion is paltry relative to the size of the US external imbalance • it would take a large allocation only for the US In that case, the Fed could try to reduce the high weight of dollars in official reserves • exchanging SDRs for dollar assets held by foreign central banks
–
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The SDR structural weaknesses
3.
–
…..SDRs do little to solve the IMS fragility problem
Bilateral SDR-dollar swap would be incapable of mopping up the “excess” supply of dollars: • the swap leaves the size of the US monetary base unchanged • to reduce it, the Fed would have to sell voluntarily in the market place the T-bills received in exchange of SDRs
–
Conclusion: with the SDR scheme the problem of sharing the burden of adjustment remain unresolved
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The SDR structural weaknesses
4.
–
Finally, SDRs assign a passive role to the IMF
once a decision has been made by an allocation of SDRs, the IMF has no discretionary power on its uses IMF merely operates as a broker matching Deficit Countries to Surplus Countries for SDR-international money swaps.
–
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Improving SDRs
• Zhou Xiaochuan (Governor of the Bank of China) has recently proposed:
To transform the SDR from an artificial basket currency into one backed by assets To establish a settlement system between the SDR and national currencies so as to make the SDR a fully fledged money To link SDRs to a specific institution that would be responsible for their management and their value, in other words they have to be someone’s liability
1.
2.
3.
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Improving SDRs
• Improving the SDR scheme is only a step in the direction of reinforcing the IMS….. • …..but it is still inadequate due to:
– the exogeneity principle underlying the supply of SDRs – allocations unconnected with the size of external imbalances – the absence of rules on burden sharing in external adjustment
Alessandrini & Fratianni Ancona, october 7-2009
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The need of a supernational money
• The old Substitution Account tried to solve the exogeneity limit, proposing an endogenous creation of SDRs (Committee of Twenty 1974, IMF Interim Committee 197879):
– Central Banks could open an account in SDRs by depositing dollar assets at the IMF – the S.A. never came to light because: • IMF board did not accept to bear an exchange rate risk from unhedged position having $ assets and SDR liabilities
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The SBM solution
• Our proposal:
1. the creation of a supernational bank money (SBM) within the institutional setting of a multilateral clearing system of debit and credit entries restricted to central banks 2. As a first step, the FED and the ECB could take the initiative transferring to the IMF earning assets denominated in $ and euros, respectively, against an equivalent amount of SBMs
3. SBMs would have the property of a basket currency with the attendant risk diversifying characteristics
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The SBM solution
The SBM scheme:
1. goes beyond Zhou Xiaochuan’s recommendations 2. overcome the exchange rate risk limit of the Substitution Account
•
SBMs differ from SDRs in the two fundamental ways:
1. SBMs are created endogenously, as a result of actions taken by participating countries
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The SBM solution
2. The clearing system operates on a banking principle, in line with the Keynes Plan: – The settlement of credit and debit between central banks would occur through their SBM accounts – The clearing institution could extend temporary overdraft facilities to deficit countries, restricted by previously agreed quotas – This implies a (temporary) increase in the world monetary base
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The SBM solution
• SBM would solve the impasse that impeded the adoption of the Substitution Account, implying: – No unhedged position: • the clearing system will send back dollar assets to the Fed in change of an equivalent value of SBM, debted to the Fed’s SBM account
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The SBM solution
• SBM reduce the key-currency countries’ “exorbitant privilege” – No automatic sterilization: • Dollar holders exchange SBMs for dollar reserves by selling dollar assets in the open market and by converting dollar deposits at the Fed with SBMs at the clearing institution: Both the Fed’s reserves in SBM and the US monetary base are reduced – Uses of key currency are progressively limited to “working balances for the daily management” in the exchange markets SBM is a feasible step forward in reducing the asymmetries of the current IMS.
•
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The SBM solution
• The clearing system operates with a fully-fledged agreement by partecipating countries on explicit rules of game, such as:
• size and duration of overdrafts • designation of countries that would have to bear the burden of external adjustment • coordination of monetary policies objectives.
• The costs of adopting a supranational money is declining relative to the expected costs of a collapse of dollarbased system
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Incentive compatibility
•
•
In the short run, US has no interest in stopping the benefits from excessive consumption financed with low interest rate capital inflows. Over the longer run, US may feel otherwise for two reasons – Deterioration in the brand name of the dollar and erosion in the market share of dollar-denominated assets.
Current financial tsunami can only accelerate the de-branding of the dollar.
–
Risk that the dollar standard may come to an end abruptly.
The consequences: a sharp increase in U.S. interest rates and US depression and strong negative spillovers in the rest of the world.
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Incentive compatibility
•
•
Old periphery (e.g., Europe) would pay in terms of negative spillovers from sudden dollar-based collapse. The interest of new periphery (e.g., BRICs) in cooperating would come:
1. from the benefits of diversification away from $ assets: however SBM would be only a substitute (and not a complete replacement) for $ assets in official reserves from the larger role that creditor countries like China would play in the IMS
2.
•
As a quid pro quo, the international community is entitled to ask China to share the responsibility of the external adjustment.
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