A New “Beijing Consensus”? C.P. Chandrasekhar

Nobel Laureate Joseph Stiglitz has written an article in the Financial Times dated April 1, 2011 arguing that a substantially enhanced issue of Special Drawing Rights (SDRs) by the IMF should be the first step in the reform of the international monetary system. The article is of special significance because it is based on a statement issued by 18 leading economists from across the globe calling themselves the Beijing Group, which includes nine known Chinese figures.

Few would object to the idea that the IMF must further enhance the allocation of SDRs and alter its distribution to help countries deal with situations of balance of payments stringency. But it is difficult to believe that the issue of SDR’s would offer a solution to the problem that the United States and the dollar do not have the requisite economic strength to warrant the dollar’s status as the world’s reserve currency. The problem is that the US is not the world’s most competitive economy, that the dollar has for long not been backed by gold, and that there are just too many dollars circulating globally and too much wealth invested in dollar denominated assets to ensure confidence in the currency. Yet, there is no other currency that appears likely to emerge as an alternative in the foreseeable future.

The Beijing Group advances three arguments in support of the SDR as an alternative reserve. The first is its view that it is because a national currency such as the dollar serves as reserve that the burden of adjustment to balance of payments imbalances falls on deficit countries, resulting in a global recessionary bias. Second, that the use of a national currency like the dollar as reserve forces the US to run unsustainable current account deficits to ensure that there is adequate global liquidity, and raises the danger that any effort of the US to shrink those deficits can generate global difficulties. And, third, that the dollar as reserve forces developing countries to accumulate large surpluses to ”self-insure” themselves against future balance of payments crisis.

There are two difficulties associated with this line of reasoning. One is that the reading of the global economy and its functioning implicit in each of these arguments is questionable. The second is that even if the reasoning is correct it does not explain why the SDR is an alternative.

Implicit in the Beijing Group’s statement is the assumption that global problems arise solely or substantially because global outcomes result from the interaction of independent nation states. This underestimates the role of large corporations and finance capital. Once we take account of the motivations that drive corporations, especially the obvious one of maximising profits, an important determinant of the distribution of current account surpluses and deficits in a world of globally mobile capital and technology is the search of transnational firms for low cost production locations. Such locations normally tend to be a few countries with a large reserve of cheap labour. As a result the most productive, best-practice technologies get combined with cheap labour, raising the level of global surpluses and inducing an underconsumptionist, deflationary bias into the system. It is difficult to see how just the availability of more of any reserve would counteract this tendency.

The reserve accumulation in some countries resulting from this process is compounded by flows of purely financial capital, encouraged by the accumulation of relatively cheap liquidity in the global financial system. That has resulted, inter alia, from the US government’s exploitation of its position as the home of the world’s reserve currency to function as if it faces no national budget constraint and undertake huge expenditures abroad aimed at maintaining its hegemony. The deficits associated with such expenditure have in turn been financed by the reverse flows of dollar surpluses invested in dollar-denominated assets. Hence, it is unlikely that the US would agree to a substantially enhanced issue of SDRs in order to create an alternative reserve that would deprive it of access to a global mint.

Can the SDR serve as alternative reserve? Created in 1969, the SDR was initially seen as a supplemental reserve which could help meet shortages of the two then prevailing reserve assets: gold and the dollar. The IMF issues credits of SDRs to its member nations, which can be exchanged for freely usable currencies when required. The value of the SDR was initially set to be equivalent to an amount in weight of gold (0.888671 grams) that was then also equivalent to one U.S. dollar. After the collapse of the Bretton Woods system in 1973, however, the value of the SDR was reset relative to a weighted basket of currencies, which today consist of the euro, Japanese yen, pound sterling, and U.S. dollar, and quoted in dollars calculated at the existing exchange rates. The liquidity of the SDR is ensured through voluntary trading arrangements under which members and one prescribed holder have volunteered to buy or sell SDRs within limits. Further, when required the Fund can activate its ”designation mechanism”, under which members with strong external positions and reserves of freely usable currencies are requested to buy SDRs with those currencies from members facing balance of payments difficulties. This arrangement helps ensure the liquidity and the reserve asset character of the SDR. So long as a country’s holdings of SDRs equal its allocation, they are a costless and barren asset. However, whenever a member’s SDR holdings exceeds its allocation, it earns interest on the excess. On the other hand, if a country holds fewer SDRs than allocated to it, it pays interest on the shortfall. The SDR interest rate is also based on a weighted average of specified interest rates in the money markets of the SDR basket currencies.

The volume of SDRs available in the system is the result of mutually agreed allocations (determined by the need for supplementary reserves) to members in proportion to their quotas. Till recently the volume of SDRs available was small. Since than SDRs have been allocated on four occasions. An overwhelming proportion of the allocation has occurred in the aftermath of the 2008 financial crisis. But even now the quantum of these special reserves is well short of volumes demanded by developing countries.

Does the recent large increase in the amount of SDR’s allocated herald its emergence as an alternative to the dollar? There are two roles that the SDR can play, which favour its acceptance as a reserve. First, it can help reduce the exposure of countries to the dollar, the value of which has been declining in recent months because of the huge current account deficit of the US, its legacy of indebtedness and the large volume of dollars it is pumping into the system to finance its post-crisis stimulus package. Second, since its value is determined by a weighted basket of four major currencies, the command over goods and resources that its holder would have would be stable and even advantageous.

There are, however, five immediate and obvious obstacles to the SDR serving as the sole or even principal reserve. First, the volume of SDRs currently available are distributed across countries and is a small proportion of the global reserve holdings estimated at $6.7 trillion at the end of 2008 and of the reserve holding of even a single country like China. Since all countries would if possible like to hold a part of their reserves in SDRs, the fraction of the SDR hoard that would be available for trade against actual currencies would be small, implying that even with recent increases in allocations the SDR can only be a supplementary reserve. Second, expansion of the volume of SDRs in circulation requires agreement among countries that hold at least 85 per cent of IMF quotas. With the US alone having a close to 17 per cent vote share, as of now it has a veto on any such decision. It is unlikely to go along with the decision to deprive it of the benefits of being the home of the reserve currency.

Third, since SDR issues are linked to quotas at the IMF and those quotas do not any more reflect the economic strength of members, the base distribution of SDRs is not in proportion to the distribution of reserve holdings across countries. Reaching SDRs to those who would like to hold them depends on the willingness of others to sell as noted earlier. Fourth, since the value of the SDR is linked to the value of four actual currencies, the reason why a country seeking to diversify its reserve should not hold those four currencies (in proportion to their weights in the SDR’s value) rather than the SDR itself is unclear. This would also give countries flexibility in terms of the proportion in which they hold these four currencies (which is an advantage in a world of fluctuating exchange rates, since weights in the SDR are reviewed only with a considerable lag, currently of five years). Finally, as of now SDRs can only be exchanged in transactions between central banks and not in transactions between the government and the private sector and therefore in purely private sector transactions. This depletes its currency-like nature in the real world. It also reduces the likelihood that a significant number of economic transactions would be denominated in SDRs.

Thus, the idea of a wholly new currency serving as a unit of account, a medium of exchange and a store of value at the international level does appear a bit far-fetched. The denomination of trade in that currency, the issue of financial assets denominated in that currency and the quantum and distribution across countries of the currency issued have to be all decided jointly and with consensus. That does appear near impossible as of now.

(A shorter version of this piece has appeared on the Triple Crisis Blog )