Af­ter the Dol­lar

Financial Mirror (Cyprus) - - FRONT PAGE - By Jose An­to­nio Ocampo

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.

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