After the Dollar
It is symbolic that the recent BRICS summit in Fortaleza, Brazil, took place exactly seven decades after the Bretton Woods Conference that created the International Monetary Fund and the World Bank. The upshot of the BRICS meeting was the announcement of the New Development Bank, which will mobilise resources for infrastructure and sustainable development projects, and a Contingent Reserve Arrangement to provide liquidity through currency swaps.
The Bretton Woods Conference marked one of history’s greatest examples of international economic cooperation. And, while no one can say yet whether the BRICS’ initiatives will succeed, they represent a major challenge to the Bretton Woods institutions, which should respond. Rethinking the role of the US dollar in the international monetary system is a case in point.
One key feature of the Bretton Woods system was that countries would tie their exchange rates to the US dollar. While the system was effectively eliminated in 1971, the US dollar’s central role in the international monetary system has remained intact – a reality that many countries are increasingly unwilling to accept.
Dissatisfaction with the dollar’s role as the dominant global reserve currency is not new. In the 1960s, French Finance Minister Valéry Giscard d’Estaing famously condemned the “exorbitant privilege” that the dollar’s status bestowed upon the United States.
The issue is not merely one of fairness. According to the Belgian economist Robert Triffin, an international monetary system based on a national currency is inherently unstable, owing to the resulting tensions among the inevitably divergent interests of the issuing country and the international system as a whole.
Triffin issued his warning more than 50 years ago, but it has recently gained traction, as China’s rise has made the world increasingly disinclined to tolerate the instability caused by a dollar-denominated system. The solution, however, lies not in replacing the dollar with the renminbi, but in strengthening the role of the world’s only truly global currency: the IMF’s Special Drawing Rights.
Following the creation of SDRs in 1969, IMF members committed to make them “the principle reserve asset in the international monetary system,” as stated in the Articles of Agreement. But the peculiar way in which SDRs were adopted limited their usefulness. For starters, the separation of the IMF’s SDR account from its general account made it impossible to use SDRs to finance IMF lending. Furthermore, though countries accrue interest on their holdings of SDRs, they have to pay interest on the allocations they receive. In other words, SDRs are both an asset and a liability, functioning like a guaranteed credit line for the holder – a sort of unconditional overdraft facility.
Nonetheless, SDRs have proved to be useful. After initial allocations in 1970-1972, more were issued to increase global liquidity during major international crises: in 1979-1981, in 1997, and, in particular, in 2009, when the largest issue – the equivalent of $250 bln – was made.
While developed countries, including the US and the United Kingdom, have drawn on their allocations, the major users have been developing and, in particular, low-income countries. In fact, this is the only way in which developing countries (China aside) share in the creation of international money.
Several estimates indicate that, given the additional demand for reserves, the world could absorb annual allocations of $200300 bln or even more. This has prompted many – including People’s Bank of China Governor Zhou Xiaochuan; the United Nations-backed Stiglitz Commission; the Palais Royal Initiative, led by former IMF Managing Director Michel Camdessus; and the Triffin International Foundation – to call for changes to the international monetary system.
In 1979, the IMF economist Jacques Polak, who had been part of the Dutch delegation at the Bretton Woods conference, outlined a plan for doing just that. His recommendations include, first and foremost, making all of the IMF’s operations in SDRs, which would require ending the separation of the IMF’s SDR and general accounts.
The simplest way to fulfill this vision would be to allocate SDRs as a full reserve asset, which countries could either use or deposit in their IMF accounts. The IMF would use those deposits to finance its lending operations, rather than having to rely on quota allocations or “arrangements to borrow” from members.
Other provisions could be added. To address developing countries’ high currency demands, while enhancing their role in the creation of international money, a formula could be created to give them a larger share in SDR allocations than they now receive.
The private use of SDRs could also be encouraged, though that would likely be met with strong opposition from countries currently issuing international reserve currencies, especially the US. Keeping SDRs as pure “central-bank money” would eliminate such opposition, enabling them to complement and stabilize the current system, rather than upend it.
Just as the Bretton Woods framework restored order to the global economy after WWII, a new monetary framework, underpinned by a truly international currency, could strengthen much-needed economic and financial stability. Everyone – even the US – would benefit from that.