Ethos Perspectives

In Reserve

Triffin’s solution to the dilemma was the creation of new reserve units, to allow the US to reduce its balance-of-payment deficits without threatening global economic expansion. The suggestion was not taken up at the time, but in 1968, after the collapse of the Gold Pool, the IMF members agreed to create SDRs. The first issue of SDRs was in 1970 and 1971, but by then it was too late to rescue the Bretton Woods system. In August 1971, President Nixon announced the closure of the gold window. By 1973, most developed countries had allowed their currencies to float against the dollar.

This is not the first time a new reserve currency has been proposed — the Keynes Plan included the creation of a global bank which could issue its own reserve currency, the "bancor" — and will probably not be the last. Hot on the heels of Governor Zhou’s paper on a new reserve currency were the interim recommendations of the UN Expert Commission on Finance chaired by Joseph Stiglitz. The Commission recommended a thorough revamp of the international finance system, including the creation of a new global reserve system. The volatility of the dollar system suggested that the system was fraying. What was needed was a new reserve system, either based on SDRs or a new currency, to reduce volatility and create greater stability in the international monetary system. ¹² There is new interest in the SDRs: at the April 2009 summit, the G20 countries authorised the IMF to issue US$250 billion in new SDRs, to boost the reserves of emerging countries (and of other countries, since SDRs are allocated according to members’ quotas). The fresh issue, however, will increase the share of SDRs in international reserves to no more than 4%. Helmut Reisen of the OECD Development Centre estimated that for SDRs to be the principal reserve asset, the IMF would need to issue another US$3 trillion worth. ¹³

In sum
Every crisis brings calls for reform, and the larger and more systemic the crisis, the bolder and more fundamental the reforms called for. It seems clear that neither the yuan nor SDRs are going to overtake the US dollar in the near future, at least not without drastic measures.

Jeffrey Frankel would have us consider the euro as a potential reserve currency as well, since it scores well in most of the determinants of reserve currency status: economic size, depth of financial markets, rates of return, and the inertia of history. The Euroland economy is roughly the same size as the US economy. Frankfurt’s financial markets are not as deep or as liquid as New York’s, but perhaps one should look to London rather than Frankfurt, though the credibility of both the US and London markets have been hurt by the financial crisis. The US dollar has performed as well as a store of value as it has other functions of a reserve currency. It does have inertia and network externalities on its side, but there could be a tipping point in future in favour of the euro. ¹⁴

It is possible, as Frankel notes, that the next global reserve system will be a multiple reserve currency system, rather than one dominated by a single currency: the dollar, the euro, SDRs, the yuan. We are always on the lookout of the next major realignment of global power, the new world order. This is one worth keeping in view.

Prepared by:
Koh Tsin Yen
Senior Researcher
Centre for Governance and Leadership & Centre for Public Economics
Civil Service College

Page 1 I 2 I 3 I 4