Monday, May 16, 2016

Claudio Borio (BIS) Speech - Followup Article

The recent speech by Claudio Borio of the Bank for International Settlements that we covered here contains some comments about a hypothetical possible role in the future for the SDR. Since we have covered that topic here in depth, I wanted to feature the remarks in this speech by Mr. Borio below and then add a few additional comments of my own. Please note the comment from Dr. Warren Coats (former IMF) offered for readers here in the added comments section below.

from page 6 of the speech under the subtitle:  Possible Solutions:

"First, it is not clear to me that more pluralism is the answer to the main problem. True, it may impose greater discipline on the dominant country. Greater choice must surely help.(15) But more pluralism, per se, does not address the root problem, ie the absence of a global anchor. Could there not be a race to the bottom rather than to the top? And even if the SDR was placed at the system’s centre, what would anchor the SDR? (16) 

Short of creating a supranational central bank that operated in SDRs, this would require an explicit link to national monetary policies; otherwise, the SDR would simply remain an additional instrument with but a limited impact on global financial conditions, at least in tranquil times. For instance, the ECU acted as a common reference for exchange rate adjustments in the European Monetary System (EMS), although even then the system was far from symmetrical, with the DM playing the main anchor role. (17)"

15) See Zhou (2009) and Coeuré (2015); for a view that the discipline is not working, see Mishra and Rajan (2016).

16) For discussions of the role of the SDR, see eg Mateos y Lago et al (2009), Zhou (2009), Padoa-Schioppa (2010) Camdessus et al (2011) and IMF (2011). 

17) Moreover, if the SDR was used widely to denominate international assets and liabilities but remained an amalgam of national currencies, it is not clear that this would help support financial stability in a crisis. Runs on international banks with SDR denominated liabilities instead of dollar-denominated liabilities, as experienced in 2008, would have required cooperation in funding operations by all of the central banks whose currencies were included in the SDR. Arguably, this may have complicated the response (BIS (2010, p 55)). 

My added comments: I want to be careful here not to read in something in these comments that is not there. First, let's just try to summarize what I think are some key bullet points from this section of the speech by Mr. Borio.

- he is not sure if moving to plural currency regime (where the US dollar is less dominant) will make the system more stable or not

- he says that will not address "the root of the problem" which he then says is "the absence of a global anchor"

- he asks a hypothetical question: "even if the SDR were placed at the system's centre, what would anchor the SDR?"

-he goes on to say that trying to use the SDR without a supranational central bank that operated in SDRs would require "an explicit link to national monetary policies"

Now I will attempt to offer some observations about these comments that are strictly my own ideas and not anything that the BIS or any BIS official has said. Also, the comments below about Dr. Coats Real SDR Currency Board proposal are my own as well (except for the direct quote Dr. Coats sent me below). Neither Dr. Coats or anyone at BIS has suggested to me that a proposal to use the SDR at the center of the global financial system is currently under consideration.

These comments by Mr. Borio are fascinating to me because of the research I have done on the "Real SDR Currency Board" proposal by the former head of the SDR Division at the IMF (Dr. Warren Coats). Dr. Coats not only has proposed making the SDR (the "Real SDR" under his proposal) the center of the system, he has also written a paper on why he feels the world needs a global reserve currency "with a hard anchor." 

It's hard for me to ignore the similarity in the use of the term hard anchor by Dr. Coats and the question raised by Mr. Borio as to "what would anchor the SDR?" As I read Dr. Coats proposal, it seems to me that it may attempt to address the questions raised by Mr. Borio about how to anchor the global financial system to make it more stable. 

Perhaps the best thing to do here is to simply refer readers to the proposal by Dr. Coats for their own study to see if you think they are talking about the same idea and if Dr. Coats proposal would address the issues raised by Mr. Borio.

Here is the link to Dr. Coats Real SDR Currency Board Proposal:

Here is the link to Dr. Coats paper on why the world needs a global currency with a hard anchor:  -  Blog article on this 

I asked Dr. Coats what he thought about the remarks by Mr. Borio on the SDR and he offered these comments:

"The reason Mr. Borio does not consider the SDR a sufficient anchor is that its value depends on other currencies, whose value is determined by the monetary policies of the countries that issue them, which are not “anchored” in any clear way. While I have argued that expanding the use of the SDR would be helpful, my Real SDR would, of course, replace the currency valuation basket with a goods valuation basket. Issuing these Real SDRs under currency board rules would remove the need for a “supranational central bank” that decided how many to issue." (I added the underline for emphasis)

I would like to add that Dr. Coats has gone above and beyond in donating his time to help me better understand his proposal and really the entire idea of the SDR as a potential global currency. He has done this purely because he wants to make his knowledge and experience available to those of us without a background in these complex topics. We owe him a debt of gratitude for taking time to offer readers here his time, knowledge and experience. It is very hard to find people with his level of knowledge of the system who will take time to share it. I know because I look for them constantly in trying to get the best information I can for readers here.

My take on all this based on these highly credible information sources is that there are always ongoing discussions and ideas within the global community about how to reform the system and make it more stable in the future. It appears to me that no one proposal has been adopted and that some big questions still remain to be resolved. It appears that study, discussion, and exchange of ideas will continue over time. If another major crisis were to erupt, it would probably speed up any process that involved major systemic change. That is my own belief and not anything I have been told by any financial official. It just makes sense to me.

One question I get quite often is if any of these proposals include the concept of using gold as the "hard anchor" for any potential future global currency. My best understanding of the situation is that using gold alone as a anchor (or backing if you prefer that term) has not been part of any official proposal that I know of.

Dr. Coats explains in his writings that he prefers to use a basket of goods. He feels that would bring stability to the currency along with using a Currency Board operating under a rules based system. No one at the IMF or the BIS has ever suggested to me that using gold for currency backing is under consideration at this time. There have been some serious papers written on the idea (see examples here and here), but again, no official proposal that I know of. There have also been some highly respected economists who have recently talked about a "revaluation" for gold against currencies. We mentioned that in this recent blog article.

However, everyone who follows this topic understands that gold is an important reserve asset for central banks and the IMF. Even the BIS owns some gold reserves (2015 WGC report shows BIS holding 111 tons of gold reserves). So, I believe that whether or not gold is ever used again in any official way to back a major currency, it is viewed as an important reserve asset to be held by the nations involved in any future discussions about "global rules of the game". I think this is why both Russia and China have been steadily adding to their gold reserves in recent years.

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