US Dollar Reserve Status an "Exorbitant Privilege," IMF says (December 2009)

Rethinking Bretton Woods | Fri, Dec 18, 2009

By Aldo Caliari

Last month IMF staff released "The Debate on the International Monetary System," a Staff Position Note SPN/09/26 ("the IMF paper").[i]

Though the paper is conspicuously not a Board paper, it represents an important development in the context of an international policy debate where the dominant voices had generally ignored the need for tackling the monetary system in a significant way.

Even at the most recent G20 Leaders meeting, in Pittsburgh, the attending leaders had shied away from tackling deep reform of the monetary system that could compromise the central status the US dollar enjoys in it. This was in spite of the progress on this question made at the UN World Economic and Financial Crisis Conference, at the UN. Following on some recommendations by the UN Commission of Experts on the International Financial and Monetary System ("Stiglitz commission") the emerging global consensus at that conference recognized  the insufficiencies of the current world reserve system and "calls by many States for further study of the feasibility and advisability of a more efficient reserve system, including the possible function of SDRs in any such system and the complementary roles that could be played by various regional arrangements."[ii]
The IMF paper says the current international monetary system is something of a "non-system" and recognizes the reliance of that system on one country as a key supplier of global reserve assets gives that country an "exorbitant privilege", because of the greater liquidity of its markets and ability to borrow in its own currency abroad at a lower cost, while earning the seignorage from issuing a global currency.
An uncomfortable implication of a system giving primacy to one country's currency is that the world is "in a sense, hostage to the reserve issuer's ability to preserve its currency's value."
The paper explores possible responses both on the demand and the supply side. On the "demand" side, it argues for some alternatives to self-insurance. These include the possibility of changes to the existing credit lines, though the authors recognize the "existence of these instruments cannot be seen as a direct substitute for reserves."[iii] Another alternative that is assessed is that of increasing access to unconditional resources.
But the most far-reaching aspects of the paper can, undoubtedly, be found in the section that focuses on the "supply side" where, after declaring that the solutions to attenuate demand for reserves would at best address only a part of the problem, it analyzes potential of alternatives to the current dollar-based monetary system. Alternative systems, the paper argues, would have to be assessed against several criteria among which trade-offs are inevitable, and it mentions "stability, efficiency, political feasibility, ease of implementation, and fairness." It does not mention that, to make matters more complex, the trade-offs are not just among these criteria, but that each criteria will affect developed and developing, more or less trade-dependent economies, to different degrees. Systems that are more beneficial to some from, say, a stability perspective, will be less so to others, the implication being that trade-offs that can be beneficial to some will not be to others.
A first possible alternative the paper explores is a system where different currencies can act as reserve assets, but it mentions historical evidence that bi-currency systems tend to converge to dominant-currency ones. A second alternative is an SDR-based system. Some advantages of this system the paper mentions are that it would "spread the exorbitant privilege" across the countries whose currencies make up the SDR basket, more broadly and faster than in a multi-currency system, and that it would reduce the need for emerging and developing countries to export capital to reserve issuing countries as a way to accumulate reserves, as is the case today. On the other hand, an SDR-denominated reserve asset would be as good store of value as the stability of the component currencies, and moving to an SDR-based system would require considerable global policy coordination, including with the US. Finally, a third possibility the paper considers is a Global Reserve Asset and Currency. In this regard, the paper repeats some of the reasoning behind Keynes' proposal for a 'Bancor' and the impact this could have on reducing asymmetric adjustments.
The paper may represent just one more interesting staff paper, but it could also represent a first step towards official work in the Fund to assess groundbreaking alternatives to the US dollar-based monetary system. Even in this case, one wonders if the IMF is the right place to hold this discussion. First, the institution may not accurately assess the value of regional initiatives which are perceived -fairly or unfairly-as competition to the global approach that the IMF itself embodies (the merely cursory mention that regional initiatives deserve in the staff paper are a clear sign of this bias). Second, the trade-offs among criteria that are, in the end, considered acceptable enough to justify endorsement of a new system may not be in the best interest of developing countries. In the IMF they will be outvoted even in a scenario where the promised governance reforms materialize to their best, not to mention the veto that the main country benefitting from the current system enjoys and may use to extract concessions in any new system.
Nonetheless, it is undeniable that the fresh input and momentum that the paper brings into the debate is a sign that should be welcome.

[i] The paper is available
[ii] A/CONF.214/3, para. 36.
[iii] IMF Paper, p. 10.