World Needs New Anchor Currency, But Is SDR the Solution?

The global economy needs a new anchor currency, and the SDR could fill this role. That Writes economist Wim Boonstra this week in an analysis for Rabobank. He notes that dependence on the dollar is causing more and more disadvantages. Not only for the rest of the world, but also for the United States. That is why Boonstra argues for a reconsideration of the SDR, the IMF's basket of currencies. With some adjustments, this basket of currencies could take over the role of the dollar as an international trading currency. But is it really that simple?

'Exorbitant privilege'

Boonstra rightly notes in his analysis that having the world reserve currency is both a curse and a blessing at the same time. A blessing, because the country that issues the world's reserve currency can pay for the import of goods in its own currency. Moreover, with a world reserve currency, the country can easily finance its deficits because other countries hold that currency as a reserve. A country that issues the world reserve currency can therefore live far beyond its means on a structural basis. French President Charles de Gaulle called this in the 1960s 'America's exorbitant privilege'.

In the short term, having the world's reserve currency seems like a blessing, but in the long term, the disadvantages also become visible. The country that has the world's reserve currency will have to deal with an artificially high exchange rate, because there is much more demand for this currency worldwide than would otherwise have been the case.

This high exchange rate is good for imports, but very unfavourable for exports. In other words, companies in the country with the world's reserve currency are increasingly unable to compete with foreign countries. As a result, many companies are moving their production abroad, which means that employment is decreasing. This leads to more unemployment and discontent in our own country.

Is the SDR the solution?

Boonstra provides a clear analysis of the problematic nature of a world reserve currency. He is also right to point out that another anchor currency – such as the euro or the Chinese yuan – does not solve this fundamental problem. He writes that there is no guarantee that the EU and China are better guardians of global stability than the US.

'The fundamental problem that the domestic and external roles may be at odds with each other is not solved by this change. The problem is only shifted. It is therefore better to switch to a multipolar system, consisting of a few major currencies, with a neutral basket of currencies as an anchor.'

It is striking that Boonstra then Special Drawing Rights (SDR) of the IMF as a possible solution. This basket of currencies of the IMF has existed since 1969 as a supplementary reserve to the dollar, but has never been a success. Several central banks do hold a position in SDR, but rarely for more than a few percent. And that's understandable, because the currency basket has some major shortcomings that stand in the way of widespread adoption.

Political support

Rabobank's economist, for example, rightly points out that the IMF must first be reformed, because in its current form it does not reflect the current economic and political balance of power. Emerging economies such as China and Russia have relatively little say, even though these economies have gained a much larger market share in the global economy in recent decades. As a result, there is still little support for the use of the SDR in many emerging economies.

In 2016, the Chinese yuan added to the basket, but that was mainly a symbolic decision. With a weighting of 10.92%, the Chinese yuan would still not play a major role. Moreover, as the second largest economy in the world, China has the ambition to promote its own currency as an international trading currency. For example, the central bank has already signed currency swaps with various trading partners in recent years. And with success, because the ECB and the Russian central bank have now included the yuan in their reserves.

Who sets the course?

With a reform of the IMF and the establishment of a separate governing body, the management of the currency basket should become a lot easier, Boonstra writes. With a clear mandate, agreements on annual money growth and periodic accountability to the full IMF meeting, the SDR could be a good alternative to international payments.

In theory, that sounds plausible, but in practice it is a lot more unruly. The SDR's basket of currencies ignores the fact that many countries currently prefer to steer their own course. Europe wants to International role of the euro strengthening, Russia used Large-scale Euros international trade and China already has plans to develop a Digital Yuan.

Another problem is that countries have to jointly determine which currencies should be included in the basket and what weighting they should then be given. Both literally and figuratively, it is therefore difficult to determine the course of the SDR. This is only possible if the urgency is great, as was the case with Bretton Woods in 1944. It seems that the world is not yet ready for an international currency in the straitjacket of the IMF.

What are the alternatives?

The U.S. dollar is becoming the most important international currency, but that's mainly due to the lack of a better alternative. The dollar has also had a monopoly for decades, as the European answer did not come until 1999. The euro has proven to be a viable alternative, but it lacks a solid and sizeable capital market. A Greek or Portuguese government loan is simply not as safe as a German one. The Chinese yuan, for its part, is still not fully freely tradable.

And what about gold? Boonstra rightly notes that there was a time when gold was the international anchor currency. Gold was the reference point of value between roughly 1873 and 1914. During this period, there was a lot of prosperity and the first wave of globalization started. Gold provided stability, but could no longer fulfill that role when countries needed money to finance the war. The link between money and gold simply did not allow that.

After the Second World War, attempts were made in Europe to Taken to bring gold back into the monetary system, but the temptations of the dollar system with an abundance of credit proved too great. With the introduction of a futures market for gold in 1973, the precious metal eventually became a commodity Pushed.

At the current price of gold, it is virtually impossible to mobilize gold reserves and use them as an international means of payment. To this end, a much higher Gold price necessary. It is therefore striking to note that since the financial crisis of 2008, central banks have been buying gold on a large scale again. Is the role of gold not played out after all?

Frank Knopers

This contribution was made from Geotrendlines