The New Multi-currency International Monetary System and the SDR Future

Bruno Mazzola
Honorary Treausrer of CESI

Elena Flor

SDR: From Bretton Woods to a World Currency, Brussels, P.I.E. Peter Lang, 2019.[i]

Elena Flor, the Secretary General of the Robert Triffin International, traces in this book the evolution of the international monetary system over the last two centuries: first a system based on gold (gold standard), then, starting from the Conference of Bretton Woods, one on the dollar convertible into gold at the fixed exchange rate of $35 per ounce (gold exchange standard), and subsequently, from 1971, inconvertible (dollar standard), to arrive, thanks also to the emergence on the international markets of the Euro, at the current multi-currency system.

Two positions were confronting each other in Bretton Woods. The first was that of J. M. Keynes, who proposed the creation of a clearing union and an international reserve unit, the bancor, to a certain extent anticipating the SDR. The book contains in the appendix two important versions of Keynes’ Plan (one of February 1942 and one of April 1943), which highlight the foresight of the British economist and the nature of the debate in which, amid a still raging war, the  parties to the conference were already concerning themselves with laying the foundations of a system that at the end of the war could allow the countries exhausted by war to recover and move towards a new development.

The second position under discussion in Bretton Woods was that of H. D. White, the American negotiator, who wanted to entrust the role of international reserve currency to the US dollar: obviously, in the moment when the United States was the only country able to finance post-war reconstruction, it was the latter position that prevailed.

However, it was Robert Triffin who immediately pointed out how unfair and incongruous an international monetary system was which had a national currency as its reserve currency (the Triffin’s dilemma); and he highlighted why the world economy cannot properly function without a world currency.

In fact, the problems came to the surface during the sixties, when the United States began to have its balance of payments in the red and, due also to the war in Vietnam, financed by printing money, there was an excess of dollars in circulation and a loss of confidence in the dollar itself, which forced President Nixon in 1971 to declare the dollar’s inconvertibility into gold.

Meanwhile, in 1967, within the International Monetary Fund, in order to expand the availability of reserve instruments complementary to the dollar and to gold, the Special Drawing Rights had been created: the creation of the SDR was essentially reviving Keynes’ idea of the bancor, based on the need to have “an instrument of international currency having general acceptability between nations… governed by the actual current requirements of world commerce,… also capable of deliberate expansion and contraction to offset deflationary and inflationary tendencies in effective world demand”.

It was under the leadership of two distinguished negotiators, Rinaldo Ossola and Robert Triffin, that the principle was established that the SDR should become a real instrument of international liquidity destined to supplant over time in that role the national currencies, and in particular the dollar.

Initially, an SDR was equal to the gold content of one dollar; starting from 1974, it was however transformed into a currency-basket (first consisting of sixteen currencies, subsequently reduced to five). Thus began the de-dollarization of the international monetary system, thirty years after Bretton Woods, and the end of the fixed exchange-rate regime, followed by a gradual process of regionalization of the currency areas, still in progress.

An important chapter in the evolution of the System towards a multi-currency structure (currently with three main currencies – dollar, euro, renmimbi – and two minor ones – yen and pound) was the process of European monetary unification, to which Elena Flor dedicates a significant part of the book.

Also in the construction of the Euro a central role was played by Robert Triffin, who returned to Europe from the Monetary Fund to collaborate in particular with Padoa-Schioppa and Delors, and pursue this objective (the euro), which, in a framework characterized by globalization and the recomposition of the various areas at the world level, he considered to be propaedeutic to a more widespread use of the SDR itself.

The process of monetary unification in Europe developed through various phases over a period of over fifty years. It can be said that it began in 1950 with the establishment of the European Payments Union (EPU), a multilateral clearing system that put an end to bilateral settlements between European countries; it had at its base a European Unit of Account (EUA), pegged to the dollar, and the imbalances of individual countries towards the Union were financed by the Marshall Plan. The granting of credits was obviously conditional on the adoption of corrective policies.

Following the achievement of the full convertibility of the main European currencies in 1958, the EPU was replaced by the European Monetary Agreement (EMA), and a special European Fund was created for interventions to support countries with balance of payments problems; this experience ended in 1972, in the wake of the dollar crisis.

After a period characterized by the fluctuation of European currencies against the dollar and between them (the snake in the tunnel), a crucial step in European integration was therefore the creation in 1979 of the European Monetary System (EMS), with the adoption of the European Exchange Rate Mechanism (ERM), the establishment of the European Monetary Cooperation Fund (EMCF) and the introduction of the ECU (European Currency Unit); the ECU was a basket-currency, with fixed amounts of currencies floating with respect to each other within narrow margins, and it was able to perform the function not only of unit of account, but also of value reserve and currency of exchange, until it became, on 1st January 1999, a real single currency (the Euro).

An essential role in favoring the emergence of the ECU in the markets, guaranteeing its liquidity, was its use in the denomination of a wide range of financial instruments at world level, to which the international banking system contributed in a significant manner; it also gave rise to an ECU clearing system to facilitate interbank settlements. In this regard, the book offers ample evidence of the various forms of private use of the ECU. On the other hand, as regards the SDRs, the author highlights how, up to now, there has been a too sporadic use of them as a currency for the denomination of securities and other financial assets by the markets, except for limited exceptions in the late seventies and early eighties.

The economic and monetary integration achieved in Europe can represent a valid model, replicable, obviously with the appropriate adaptations as required, in other areas of the world, and contribute to further developing the international monetary system towards a multi-currency structure. If Triffin were alive today, he would surely work on a new plan to relaunch the SDR.

A continent that requires a greater integration, first of all economic and then monetary, is for example the African one: the recent approval of the African Continental Free Trade Area (AfCFTA) may be the necessary prerequisite for the creation of an internal market without customs barriers, which can subsequently evolve towards the introduction of a single currency, the Afro, pegged to the SDR.

The serious financial crisis that broke out in the United States in 2007 and soon spread throughout the world, with heavy impacts on the real economy, made it evident once again the interest in a stable, independent currency, supported by the collaboration between states and at the service of a sustainable globalization.

Faced with the seriousness of the crisis, the leaders of the G20 approved in 2009 a massive financial program, of the order of 1.100 billion dollars, to strengthen the IMF’s capacity to intervene in support of the world economy: the program, that had President Obama’s convinced support, included, a significant increase in the Fund’s financial resources from 250 to 750 billion dollars, and a new allocation of SDRs equivalent to 250 billion dollars, in addition to other measures.

However, there was to wait until the fall of 2015 to get the US Congress to approve this program, together with the inclusion of the renmimbi in the basket, confirming a conflictual US position towards the IMF and the SDR, which it sees as a potential threat to the hegemonic role of the dollar. The US, possessing 17.46% of the quotas and 16.53% of voting rights in the Fund, still retains a veto right over decisions requiring an 85% majority. The Eurozone countries, on the other hand, do not have currently the right to veto, in the absence of unitary representation in the Fund.

The inclusion of the renmimbi in the SDR basket, despite its lack of full convertibility, is the result of an acknowledgment of the importance that China is acquiring from an economic point of view on the world scene: according to data available in 2017, China’s contribution to the global GDP (measured in terms of PPP) was 18.3%, more or less in line with the incidence of the Chinese population on the world population. Also noteworthy is the noticeable increase in trade with China by Asian countries; and the fact that many of these have pegged their currencies to the renmimbi hints at the birth in that part of the world of a new regional area with a reserve currency of its own.

The World Bank in 2016 has, among other things, recently carried out an initial issue on the Chinese domestic market, worth 2.8 billion dollars, of securities denominated in SDR and payable in renmimbi, reserved for Chinese investors, as a diversification tool with respect to the dollar, but more stable and safer than the latter: an issue reminding the first emissions in ECU in the early eighties of the last century, carried out by Italian, Belgian and French banks.

The international monetary system is therefore increasingly becoming multi-currency. Countries whose currencies could gain increasing weight in the near future, up to becoming part of the SDR basket, could be Brazil, India and Russia.

Looking at the future, however, and in particular at a future in which the after-effects of the 2007 crisis are not yet completely absorbed and new symptoms of crisis seem to be appearing on the horizon, we need to think about what developments can be anticipated for the SDR.

In this regard, Elena Flor points out that “replacing the dollar with other national or supranational currencies can help stabilize and finance regional areas of high-level economic integration, and must therefore be encouraged”, but that the dollar, the euro, the renmimbi and other minor currencies cannot become in turn, in order not to fall prey themselves to the “Triffin dilemma”, a world currency, whose functions are the traditional ones: unit of account, reserve instrument (O-SDR), and public or private financial instrument placed on the market (M-SDR).

As a unit of account, the SDR is already used in many areas, but in future it would be desirable for it to be used more in fixing the prices of raw materials, given its lower volatility, especially compared to the dollar.

As a reserve instrument, despite the Second Amendment to the Articles of Agreement contemplates the commitment to make the O-SDR the “principal reserve asset of the IMF”, its importance is still limited by the lack of consensus among the member countries of the Fund. The ideal solution would be to create a multilateral reserve currency issued by a central bank, that is to say “a liquid liability that is not the debt of any individual country”: a goal that is at the moment impossible to reach, because the political forces and the decision-making processes operate nationally, while the economic and financial problems are global.

Progressively strengthening the role of the Official SDR, as suggested by the interesting Report of an SDR Working Party of May 2014, enclosed in the appendix of the book, would however be possible through measures such as:

• - allowing the IMF in crisis situations to act as lender of last resort by issuing SDRs to finance  member countries in particular need;
• - providing for the possibility of allocating SDRs targeted to emerging or developing countries in need of liquidity, instead of generalized allocations to all member countries;
• - allowing member countries to periodically convert part of their reserves into assets denominated in SDR;
• - making the SDR more attractive by basing its interest rate on medium- to long-term yields, and simplifying its conversion into market currencies, with an even temporary intervention by the IMF until such transactions can be carried out by private intermediaries.

An indispensable condition for expanding the use of the SDR as a reserve currency, as the experience of the ECU clearly shows, would however be the development of a sufficiently liquid SDR private market. To this end, it would be also necessary to set up a clearing system, operated for example by the Bank for International Settlements (BIS). The process should be triggered by the major international financial institutions, governments and other public operators active in the financial markets; the IMF itself could issue long-term securities denominated in SDR.

To do all this, a political will is needed and times will not be short; but Elena Flor comes to the conclusion that “when this process will be completed, the three SDRs will be only one: the international currency”.

A very last look at the future, on the wake of the fast technology developments, relates to the forthcoming use of virtual currencies, such as the bitcoin, and at the role that the SDR could play in this new scenario.

Christine Lagarde, Managing Director of the IMF, in a speech on September 2017,  said that at the moment these virtual currencies would pose many challenges to the current system of currencies and to central banks, because they are “too volatile, too risky…many are opaque…and some have been hacked”. However, there is at world level a “growing demand for new payment services”; so, as far as the payment system is concerned, the challenge is more open and in the future some might have an interest in “hold[ing] a virtual currency rather than dollars, euros…”, also because “virtual currencies could actually become more stable”. At that point, the “digital version of the SDR” could be the ideal candidate.

[i] Jointly published by the Robert Triffin International and the Center for Studies on Federalism in Turin (Italy). The English edition includes three Annexes:  A- Before Bretton Woods – The Keynes Plan. B- Using the SDR as a Lever to Reform the International Monetary System – Report of an SDR WorkingParty. C- The Robert Triffin International