Related Links ~ Thursday Meeting ~ May 19, 2011 ~ Bretton Woods Committee Annual Meeting ... - China PBOC's Yi: Convertible Yuan Not Needed For SDR ... - **IMF SDR Basket ~ China PBOC Vice Gov: IMF Currency Basket Could Include BRICS Currencies - (09') ~ IMF poised to print billions of dollars in 'Global Quantitative Easing' (super currency ~ SDRs) (Soros and Truman)May 18, 2011
The international monetary system needs reform. The present system, dominated by reserve holdings of US dollars, places an unsustainable burden of creating reserves on the US.
While the US is privileged, in the short run, to issue a reserve currency, it hinders the productive capacity of the country’s economy in the long run.
Recently Joseph Stiglitz, the Columbia University professor and Nobel laureate, proposed a solution, suggesting that the role of special drawing rights should be expanded through new issues and by increasing their use in International Monetary Fund lending. In essence, the Stiglitz proposal aims to move to a world where reserve needs are met by these IMF credits known as SDR allocations rather than by building precautionary reserves.
Mr Stiglitz’s proposal can be seen as a process in which member countries swap their US dollar reserves for SDRs. The assets on the balance sheet of the IMF would be composed of the current members’ currencies, and the liabilities of the IMF would be the SDRs. All exchange rates would be priced in SDRs and they would be used as unit of account and exchange. This approach would, in effect, make the IMF the world’s central bank.
Seventeen prominent economists and policy makers endorsed Mr Stiglitz’s proposal to transform the SDR into an international currency to rival the dollar, as evidenced in a the article A Modest Proposal for the G-20, but the idea is incomplete.
Barry Eichengreen, economics professor at the University of California, Berkeley, argues in The Bear of Bretton Woods the problem is that SDRs are not a currency that can be used to settle cross-border transactions or as a unit of value in which to denominate international bonds. That means that there are no private markets for SDRs, and it is not evident that it feasible to create such markets.
Another consideration is that currencies are far more than a medium of exchange. Acquisition of a reserve currency reflects trust and confidence in a particular society. It is a vote of confidence in the country’s stability and social norms such as liberty, peace and justice. In other words, domestic currencies that serve as reserve currencies are backed by a set a “values”, including accountable and responsible domestic policy making institutions.
Furthermore, a reserve currency has to be freely convertible, have a stable wealth storage value and provide an attractive environment for commerce due to trust in the rule of law. If all those favourable conditions apply, domestic currencies represent a call on the domestic wealth, resources and industriousness of a nation. It is not possible for the IMF to pool currencies that do not have those properties and create an accepted medium of exchange.
We need to understand what the idea, set out in Mr Stiglitz’s proposal, is. Is it a substitution for existing reserves (such as China’s $3 trillion largely in US dollars) or does it pre-empt prospective reserve accumulation by allocating additional SDRs? If it is a “substitution for reserves” account to accommodate China’s desire to limit its exposure to the US dollar, we need to know who is going to bear the exchange risk.
In short, Mr Stiglitz’s proposal is flawed if there are no limits and controls on subsequent reserve accumulation and if it does not facilitate diversification unless the collective membership of the IMF is ready to cover the foreign exchange risk on behalf of China transparently. One doubts such largess by the IMF’s membership.
Allocating additional SDR in large amounts is another possibility. However, we should note that, according to the IMF, global foreign exchange reserves were about $9 trillion last year and they are growing at the rate of more than $1 trillion per year. Does the proposal envisage that the IMF could or should issue an equivalent amount – $1 trillion per year – of SDRs to accommodate the need for precautionary reserves? For that we need to recall that the IMF injected $250bn into member nations’ foreign exchange reserves to boost liquidity amid the global economic crisis “to provide liquidity to the global economic system by supplementing fund’s member countries’ foreign exchange reserves.”
While a one-time $250bn SDR allocation done with a slight of hand by international financial bureaucrats through accounting entries might be justified in exceptional times, $1 trillion per year of SDRs becomes an enormous transfer of financial resources that is not different from any other entitlement. It cannot and should not become a norm of large regular entitlements managed by benevolent international bureaucrats to countries that end up benefitting from hundreds of billions of disposable reserves.
This leads to the question of who would determine the pace and exchange rate at which the new (more inclusive) SDRs would be issued by the IMF. Such a system could undermine market discipline through diffused decision making and collective burden sharing. Would the IMF become the undisciplined world central bank, issuing SDRs with abandon and undermining the domestic financial stability of member countries? Does the proposal look at the fiscal and trade problems of member countries, which would become the collective problems of the IMF members?
Alternatively, the decision making process on issuing SDRs at the IMF could end up being complicated, fraught with politics and therefore slow in responding to a crisis. It might end up being far from the rapid decision making of a central bank and therefore useless in a crisis.
While the name of Mr Stiglitz’s monthly column on Project Syndicate is I Dissent: Unconventional Economic Wisdom one ends up concluding that this time the dissent is going too far. One is left with the conclusion that it is not a coincidence that the proposal was issued at a meeting in Beijing organized by Columbia University’s Initiative for Policy Dialogue and China’s Central University of Finance and Economics.
It is understandable why the Chinese authorities want to establish the SDR as a reserve currency. Their self-interested view is that the IMF should open a facility, the substitution account, in which countries could swap their dollar reserves for SDR reserves, presumably at a fixed exchange rate. This would enable countries to diversify out of dollars without turning the dollar exchange rate against themselves due to market impact. There aren’t obvious reasons as to why the countries affected by China’s mercantilist policies should support the proposal when China is running large surpluses and accumulating enormous reserves.
Michael Pomerleano has worked at the Bank of International Settlements and at the Bank of Israel
http://blogs.ft.com/economistsforum/2011/05/why-sdrs-will-not-fix-the-monetary-system/?catid=153&SID=google
The international monetary system needs reform. The present system, dominated by reserve holdings of US dollars, places an unsustainable burden of creating reserves on the US.
While the US is privileged, in the short run, to issue a reserve currency, it hinders the productive capacity of the country’s economy in the long run.
Recently Joseph Stiglitz, the Columbia University professor and Nobel laureate, proposed a solution, suggesting that the role of special drawing rights should be expanded through new issues and by increasing their use in International Monetary Fund lending. In essence, the Stiglitz proposal aims to move to a world where reserve needs are met by these IMF credits known as SDR allocations rather than by building precautionary reserves.
Mr Stiglitz’s proposal can be seen as a process in which member countries swap their US dollar reserves for SDRs. The assets on the balance sheet of the IMF would be composed of the current members’ currencies, and the liabilities of the IMF would be the SDRs. All exchange rates would be priced in SDRs and they would be used as unit of account and exchange. This approach would, in effect, make the IMF the world’s central bank.
Seventeen prominent economists and policy makers endorsed Mr Stiglitz’s proposal to transform the SDR into an international currency to rival the dollar, as evidenced in a the article A Modest Proposal for the G-20, but the idea is incomplete.
Barry Eichengreen, economics professor at the University of California, Berkeley, argues in The Bear of Bretton Woods the problem is that SDRs are not a currency that can be used to settle cross-border transactions or as a unit of value in which to denominate international bonds. That means that there are no private markets for SDRs, and it is not evident that it feasible to create such markets.
Another consideration is that currencies are far more than a medium of exchange. Acquisition of a reserve currency reflects trust and confidence in a particular society. It is a vote of confidence in the country’s stability and social norms such as liberty, peace and justice. In other words, domestic currencies that serve as reserve currencies are backed by a set a “values”, including accountable and responsible domestic policy making institutions.
Furthermore, a reserve currency has to be freely convertible, have a stable wealth storage value and provide an attractive environment for commerce due to trust in the rule of law. If all those favourable conditions apply, domestic currencies represent a call on the domestic wealth, resources and industriousness of a nation. It is not possible for the IMF to pool currencies that do not have those properties and create an accepted medium of exchange.
We need to understand what the idea, set out in Mr Stiglitz’s proposal, is. Is it a substitution for existing reserves (such as China’s $3 trillion largely in US dollars) or does it pre-empt prospective reserve accumulation by allocating additional SDRs? If it is a “substitution for reserves” account to accommodate China’s desire to limit its exposure to the US dollar, we need to know who is going to bear the exchange risk.
In short, Mr Stiglitz’s proposal is flawed if there are no limits and controls on subsequent reserve accumulation and if it does not facilitate diversification unless the collective membership of the IMF is ready to cover the foreign exchange risk on behalf of China transparently. One doubts such largess by the IMF’s membership.
Allocating additional SDR in large amounts is another possibility. However, we should note that, according to the IMF, global foreign exchange reserves were about $9 trillion last year and they are growing at the rate of more than $1 trillion per year. Does the proposal envisage that the IMF could or should issue an equivalent amount – $1 trillion per year – of SDRs to accommodate the need for precautionary reserves? For that we need to recall that the IMF injected $250bn into member nations’ foreign exchange reserves to boost liquidity amid the global economic crisis “to provide liquidity to the global economic system by supplementing fund’s member countries’ foreign exchange reserves.”
While a one-time $250bn SDR allocation done with a slight of hand by international financial bureaucrats through accounting entries might be justified in exceptional times, $1 trillion per year of SDRs becomes an enormous transfer of financial resources that is not different from any other entitlement. It cannot and should not become a norm of large regular entitlements managed by benevolent international bureaucrats to countries that end up benefitting from hundreds of billions of disposable reserves.
This leads to the question of who would determine the pace and exchange rate at which the new (more inclusive) SDRs would be issued by the IMF. Such a system could undermine market discipline through diffused decision making and collective burden sharing. Would the IMF become the undisciplined world central bank, issuing SDRs with abandon and undermining the domestic financial stability of member countries? Does the proposal look at the fiscal and trade problems of member countries, which would become the collective problems of the IMF members?
Alternatively, the decision making process on issuing SDRs at the IMF could end up being complicated, fraught with politics and therefore slow in responding to a crisis. It might end up being far from the rapid decision making of a central bank and therefore useless in a crisis.
While the name of Mr Stiglitz’s monthly column on Project Syndicate is I Dissent: Unconventional Economic Wisdom one ends up concluding that this time the dissent is going too far. One is left with the conclusion that it is not a coincidence that the proposal was issued at a meeting in Beijing organized by Columbia University’s Initiative for Policy Dialogue and China’s Central University of Finance and Economics.
It is understandable why the Chinese authorities want to establish the SDR as a reserve currency. Their self-interested view is that the IMF should open a facility, the substitution account, in which countries could swap their dollar reserves for SDR reserves, presumably at a fixed exchange rate. This would enable countries to diversify out of dollars without turning the dollar exchange rate against themselves due to market impact. There aren’t obvious reasons as to why the countries affected by China’s mercantilist policies should support the proposal when China is running large surpluses and accumulating enormous reserves.
Michael Pomerleano has worked at the Bank of International Settlements and at the Bank of Israel
http://blogs.ft.com/economistsforum/2011/05/why-sdrs-will-not-fix-the-monetary-system/?catid=153&SID=google
