The Great Reset has captured the world’s imagination. Conspiracy theorists, visionaries, leaders, institutions, critics and the media are all over the topic. We’ve been covering it here in Fortune & Freedom too. Last week, Nick Hubble wrote about how a future currency reset could be based on the already-existing World Bank Special Drawing Right, or “SDR”. He may well be right, and he is not alone in seeing this possibility. Indeed, in my book, The Golden Revolution, Revisited, I discuss this scenario at some length.
However, while an SDR-based global currency reset may indeed be attempted, I doubt that it would succeed at restoring global monetary and economic stability. To explain, let’s dig into the historical background of the SDR, beginning with the context in which it was created.
He who controls the basket, controls the world’s money
SDRs came into existence as a result of the founding of the World Bank and International Monetary Fund at the end of WWII. They were part of the “Bretton Woods” currency arrangements that were agreed at the eponymous New Hampshire ski resort’s international monetary conference in 1944.
Their purpose was to help reconstruct the global economy following decades of war and depression. The World Bank would fund sovereign loans, in particular for economic reconstruction and further development, and the IMF would be available to provide emergency financial assistance to member states, if required, in a liquidity crisis.
As was the case with the United Nations Security Council, the power over the World Bank and IMF resided firmly with the victorious allied powers. Thus it was they who would decide which countries would qualify for World Bank loans or, alternatively, for emergency IMF assistance. One question, however, was how such loans would be funded, and in which unit of account the books would be kept. And so the SDR currency basket was born.
SDRs are not a fungible currency, but rather strictly a unit of account, a weighted currency basket of dollars and other major economies’ currencies. As the global economy has evolved over the decades, the basket has periodically been expanded and re-weighted, most recently in 2016. Current weights for major currencies are 42% for the dollar, 31% for the euro, 8% for the Japanese yen and pound sterling, respectively, and 11% for the Chinese yuan, a relative newcomer. In October this year, another re-weighting is planned.
IMF plans for a global currency reset
The SDR unit of account may have evolved, but its role has remained unchanged. It has been mooted ever since the 1960s, however, that at some future point in time, the SDR could in fact become an actual global currency, either co-circulating with national currencies or, alternatively, as a complete replacement.
The IMF wrote a paper to this effect in 2010, pointing out the potential advantages, but also the difficulties involved in turning the SDR into an actual, fungible global currency, with the IMF serving as the “central bank” managing its supply, setting interest rates and regulating banks and other major financial institutions.
If that sounds like a plan for a future global monetary reset, that’s because it is. Fiscal policy might remain with national governments, but monetary policy would be implemented globally, circumscribing governments’ abilities to finance themselves at whatever nationally desired level of interest rates. National fiscal flexibility would thus be limited, perhaps strictly so.
As the IMF paper explains:
A limitation of the SDR … is that it is not a currency. Both the SDR and SDR-denominated instruments need to be converted eventually to a national currency for most payments or interventions in foreign exchange markets, which adds to cumbersome use in transactions…
A global currency … issued by a global central bank would be designed as a stable store of value that is not tied exclusively to the conditions of any particular economy. As trade and finance continue to grow rapidly and global integration increases, the importance of this broader perspective is expected to continue growing…
If [a global currency] were to circulate as a parallel currency but in a dominant role in place of the US dollar, then as in the [system] described above, currency account imbalances that reflect today’s situation—namely, surplus countries pegging to [the global currency] with deficit countries floating against it—would adjust more symmetrically, and perhaps more automatically, that the current [system] since the deficit currencies would be expected to depreciate against [the global currency]…
That might all sound nice on paper, but there is a glaring problem.
What happens to the dollar?
The US dollar, the current pre-eminent global reserve and transaction currency, is issued by the world’s largest external deficit country: the US. Thus the plan above would require the dollar to depreciate versus the SDR, whereas those countries with external surpluses, such as China and most OPEC members, would provide the SDR basket “anchor”.
Hence the US and other deficit countries would place pressure on the “central bank” – most probably the IMF – to issue ever-more SDRs to cover their deficits, whereas the surplus countries would be required, de facto, to accommodate such pressure, an implied subsidy for global net debtor countries such as the US, and hence an implied tax on global net surplus countries. Now, why would the creditor countries agree to that?
It’s a good question without a clear answer. Sure, some temporary arrangement could probably be agreed as part of a general global currency reset. The US, UK and other net debtors could promise to keep their government finances in order so that these don’t require funding from the surplus countries. Alongside, perhaps surplus countries could agree to spend more, so that they swing away from surplus toward deficit.
The euro as an example for the SDR
For those familiar with the “Eurosystem” of the ECB and euro-member central banks, and the so-called “Target2” system of funding internal imbalances between member states, they will see the IMF SDR plan as highly similar.
In the case of the euro, member states are unable to devalue, as is the case with the IMF SDR plan. However, in the same way that surplus countries such as Germany end up effectively subsidising the euro deficit countries, such as Italy and Spain, igniting intense political frictions from time to time, so would be the case with an SDR global currency pitting debtors against creditors.
If frictions seem high at times in the euro-area, imagine how high they would be at the global level. The EU has been growing and evolving for many decades. Two generations have grown up accepting some degree of EU authority over their countries as just the way things are. But at the global level, with essentially no such traditions; with incentives unaligned; and lacking any global hegemonic power to enforce sustainable and balanced economic policies amongst members, it is far from clear that any sustainable agreement could be reached for how to manage and maintain an SDR-centric global currency regime.
Legendary French economist and adviser to former President Charles de Gaulle, Jacques Rueff made precisely this point back in the 1960s, when international monetary tensions were also running high. He was particularly concerned about what would happen when a crisis arose:
Any international monetary crisis, any major outflow of capital … will provide an opportunity for an inflationary issue of SDRs. This in turn will lead to powerful surges of inflation in creditor countries.
And as I explain in Chapter 10 of my book,
[An] SDR-reserve system would suffer from an inherent moral-hazard problem encouraging deficit spending and domestic inflation, which would periodically spill over into international monetary crises. Under Bretton-Woods, only the United States enjoyed the ‘exorbitant privilege’ of being able to effectively force creditor countries to finance its trade and budget deficits at low interest rates. Under an SDR-based system, any country running trade and budget deficits would have the privilege.
Were Jacques Rueff alive today, he would probably see an SDR-based solution as even more unworkable than in the late 1960s, given the current degree of monetary instability and lack of global cooperation in economic and monetary affairs, both of which are an order of magnitude greater.
The game theory of international monetary relations
What Rueff correctly identified was that an SDR-based global currency does not provide for a stable global monetary equilibrium. That said, it is certainly the case that the current, dollar-centric global monetary reserve system doesn’t provide a stable equilibrium either. A rebalancing and/or reset of some sort is necessary. A monetised SDR might play some role in that. But where would that lead?
As John Nash demonstrated, and for which he won the Nobel Prize in Economic Science, a stable game-theoretic equilibrium is one in which the strategies of all players best satisfy the interests of all other players. This cannot be said about the current dollar reserve system, which is hegemonic. The global economy is not.
The US used to be a de facto economic hegemon and its external accounts used to be either in surplus or rough balance. That changed in the 1960s when the US went on a historic spending spree, not only fighting the Cold War vs the USSR, but a hot war in Southeast Asia, while at the same time funding the construction of the interstate highway system – the world’s largest construction project to that time – and hugely expanding a nascent domestic welfare state known as the “Great Society”.
Today, the global economic chessboard is far different, with economic power widely dispersed and the US and other chronic deficit countries increasingly reliant on de-facto inflationary monetary policy to maintain what is at base a global economic disequilibrium. That which can’t go on forever, won’t.
The dollar, however, has no national fiat currency heir apparent. Few would claim that the euro, with its myriad domestic governance and banking problems, is in a strong global position. Japan’s days as an emergent super-economy are long gone. China would appear to be first in line these days, but with a highly managed economy and financial system, and capital controls of various kinds in place, it is difficult to argue that the yuan, or a digital version thereof, is in a position to replace the dollar anytime soon.
As such, it is certainly possible, probable even, that the US and other major economic powers attempt an SDR-reset at some point. Perhaps the SDR basket reweighting planned for later this year will include some further planning in this regard. But if the SDR, regardless of the specific basket weightings, is unable to provide a stable and lasting global monetary equilibrium, what might be the alternative? Does history provide a guide?
Gold: the once and future international money
Indeed, history does reveal what’s likely. When it comes to providing a stable international monetary base, one candidate stands head and shoulders above all the rest: gold.
Gold is the one international money that cannot be printed, debased or devalued by any one country or group of countries to serve their economic interests at the expense of others. Gold solves the international monetary Nash Equilibrium. Could gold thus be poised to make a comeback, not only as a store of value, but as an actual international money used to settle cross-border imbalances between external surplus and deficit countries?
Gold and silver have provided the de facto monetary base since ancient times, perhaps even pre-historic, as some anthropologists claim. The global monetary and financial system may have evolved rapidly at times, such as during the Renaissance, or when banking began to link up with telecommunications networks in the 19th century. More recently, “fintech” has been disrupting banking and payments activities more generally using a variety of technologies. But there is no reason in principle why new technologies, perhaps even blockchain, which powers bitcoin and other cryptocurrencies, could not be backed by gold in some way.
Gold, as a natural substance made in supernovae or possibly stellar collisions is not something that can be created or replicated in its physical properties. It is neutral and international, weighing the same and having the same density of value the world over. It can be stored safely for nearly zero-cost when considering its unusually high value density.
These are but a few of the reasons why gold and also silver have served as the preeminent international monies for the bulk of recorded human history. A walk through the souks of Dubai or street markets of Delhi makes plain that gold is still a de facto money in much of the world; is highly liquid; is near-frictionless; and contains none of the devaluation, credit or counterparty risk associated with modern fiat currencies and their respective banking systems.
In any case, I believe the dollar’s days as the pre-eminent global trade currency are numbered. An SDR-based global currency reset may indeed be on the way. Meanwhile, new monetary and other financial technologies will continue to evolve and will almost certainly play a role. Gold waits in the wings should a stable global monetary equilibrium prove elusive, and gold is almost certain to continue rising in price as long global economic and monetary stability remain elevated.
Author, The Golden Revolution