Saturday, January 23, 2016

Dr. Warren Coats (former IMF) *** Q&A Interview *** More on The Real SDR Proposal

Recently we ran this blog article where Dr. Warren Coats explained his proposal for a global reserve currency he calls a 'Real SDR'. Dr. Coats kindly responded to a question about the potential for a global reserve currency in the future that could be used by everyone, perhaps even using modern mobile payments technology. The article was a big hit here on the blog as there is a lot of interest around the world on this topic. Dr. Coats is a former chief of the Operations Division for SDRs at the IMF.

I asked Dr. Coats if he would be willing to do a short Q&A style interview for blog readers here based on questions I get from readers and see out on the internet while doing research for the blog. He graciously agreed. Below are some questions I selected. They are based on questions I get and see asked when this topic comes up. After the Q&A section I will add a few comments based on my observations of Dr. Coats' answers.

Q: Can you give us a brief history of your 'Real SDR' proposal including when you first thought of the concept and how
it has evolved over time?

A: Economists have long been and remain at odds over the issue of fixed vs floating exchange rates.  Because I favor clear policy rules and question the ability of even the most developed and sophisticated central banks to manage the money supply successfully without an exchange rate anchor, I have generally favored fixed exchange rate policy regimes.  The gold standard era, which finally collapsed with the closing of the gold window by Richard Nixon in the early 1970, provided an outstanding example of a fixed exchange rate global monetary system.  However, I have always been uncomfortable anchoring money’s value to a single commodity.  Earlier proposals for a commodity basket anchor suffered from the high cost of its operation (transactions and storage costs on the assumption that the currency was bought and redeems with all of the items in the basket).  In 1989 I presented a paper at the Western Economic Association meeting in which I proposed a valuation basket of consumption goods and indirect redeemability (buying and redeeming the currency with assets of comparable market value rather than the goods in the basket).  At the time I was Chief of the Operations Division for SDRs at the IMF and naturally saw the already established SDR as the logical vehicle to replace gold as a hard currency anchor.  Over time I have expanded on how such a system might be implemented.  See for example:  

Q: In the proposal you call for a 'Real SDR' that could replace the US dollar in the event the dollar suffered a collapse
in a new major financial crisis. Do you think we will see such a crisis any time soon?

A: The U.S. has paid a high cost along with some benefits for supplying its currency to the rest of the world for international pricing and payments.  The U.S. balance of payments deficit necessary to supply dollars for international reserves contributed significantly to its off shoring of some of its manufacturing capacity. It has good reasons for wanting to replace its currency with an international issued reserve currency.  Given the size and depth of the U.S. economy and of the financial markets for dollar instruments, the rest of the world is happy to hold and use U.S. dollars as long as it has faith in the stability of the dollars value.  If the huge unfunded liabilities of the U.S. government (Social Security, Medicare and Medicaid etc.) that will be owed in the future are not addressed and reined in, the size of the government’s public debt will become unsustainable. If that happens, at some point foreigners will become unwilling to continue to hold U.S. debt and the dollar. (see: why the world needs a reserve asset with a hard anchor)

Q: In the absence of that kind of crisis, do you see something like your proposed 'Real SDR' evolving more gradually
over time?

A: It is essential for the U.S. to address its debt problem.  But independently it is desirable to replace the dollar and Euro or any other national currency used as international reserves with an internationally issued reserve currency. That is what I am working to achieve.

Q: In the proposal you talk about valuing the 'Real SDR' based on a basket of goods and commodities instead of a
basket of currencies as is done now. Can you elaborate on what kind of goods and commodities might be used?
Would gold possibly be included in the mix of commodities?

A: I have always left to others to determine an appropriate valuation basket.  But the principle is that it should reflect a broadly accepted idea of what stable value for money means.  Thus I think something like the basket defining the consumer price index is appropriate.  This is challenging on a global basis, but the Numbeo index seems to fill the bill:

Q: Would you view your proposed 'Real SDR' currency as still being a fiat currency even though valued using a 
basket of goods and commodities?

A: I don’t consider the designation of a currency as fiat (or not) as very useful.  I prefer to classify monetary regimes as those with a hard peg (redeemable for something else for a fixed and known price, as with the SDR valuation basket) or a soft peg (exchangeable at fluctuating market rates, as with a money growth rule or an inflation target).  All legal tender money can be used to pay taxes, the amounts of which are fixed in amounts of such currencies.  This establishes one source of its demand and market value.

Q: Some readers will of course want to see any new global reserve currency backed by gold instead of being
a fiat type currency. What are your thoughts on that view? Do you think China has any preference to see
gold re-enter the monetary system in some way?

A: See my comments to 5 above.  The choice is between fixing the price of the SDR to an amount of gold (as it was initially) or to a broader basket of goods and or commodities.  The price of gold has not been very stable.  I would prefer, and I think most people would prefer, fixing the price of the SDR to a broader basket of goods rather than to just one such as gold.

Q: A question I get from readers is why would the public trust a new version of a fiat currency if the existing 
US dollar version were to collapse in a crisis? What could be done to restore public confidence in a new
version of a fiat currency? 

A: The Real SDR Currency Board I propose would, like other existing currency boards, be fully backed with assets equal in value to the SDRs issued.  That is also true of the U.S. dollar and most other currencies, but the Federal Reserve is not obligated to redeem its currency at any particular price.

Q: If your  'Real SDR' proposal were adopted globally, how would this impact the average person in the US with
$10,000 in a savings account?

A: I think most countries will want to make their currencies part of this system either by fixing the exchange rate of their currency to the SDR or dollarizing in SDRs. Thus, the impact on US savers is that the value of their savings will be locked into the value of the SDR, either because they would be replaced with SDRs or have their exchange rate fixed to and exchangeable for SDRs.

Q: How has your 'Real SDR' proposal been received in official circles (IMF, BIS, etc). Do you get positive
feedback on the proposal?

A: I have had no feedback from the IMF, BIS or any other official body.

addendum: after reviewing a draft of this article for accuracy, Dr. Coats asked if I would include the clarification below regarding his preference for currency board rules:

"One clarification of my preference for currency board rules. While it is true that some central banks have given in to political pressure (to finance a war for example) or overly stimulate the economy, they are hard pressed to get it right even without such pressures. Getting it right means matching changes in the public’s demand for money with the supply that will keep its value constant. Currency boards require no such expertise and work the other way around. The public regulates the sum of money consistent with its demand at constant value."


My added comments: This blog has provided me the opportunity to meet some amazing people while on my quest to learn more about the global monetary system and possible future changes to it. My goal initially was to try and answer some nagging questions I had that the average person like myself understandably has when people start talking about global currencies and world money, etc.

Because we do not have access to what is discussed inside the system, it's easy to speculate and jump to all kinds of conclusions on a topic like this. Therefore, when someone with this level of expertise who has 35 years experience working inside the system is willing to answer our questions and share his knowledge and opinions, we owe him a big thank you. That is my first and most important comment.

Below is a bullet point list of some observations I have upon seeing these answers from Dr. Coats. I will add that there are some others with connections in the system who have helped me better understand some very complex issues (for the average person like myself without a background in international banking, etc). I can't discuss some things from some sources because they are not intended for the public domain. However, you can assume that my observations below are based on an improved understanding from discussions with credible sources along with the answers Dr. Coats provided in this interview. Dr. Coats advises me that there is nothing from his work at IMF that cannot be made public.

- please note that Dr. Coats has been working on this concept for a long time. This illustrates something we have said here on the blog. Under normal circumstances change takes place gradually over time. It usually takes some kind of crisis for change to take place more rapidly.

-people inside the system do understand the problems and issues that critics often bring forward. They realize that too much debt for too long will cause problems and eventually destabilize a system if not addressed. If you read Dr. Coats papers (see pages 10-14), he makes it clear that there must be strict rules regarding the supply of money that are followed. He suggests a currency board for this purpose bound by strict rules.

-people inside the system understand that central banks do abuse the right to create currency at times. Dr. Coats points this out in his writings. Others I have talked to fully understand that point as well. This is why Dr. Coats argues for a currency board that must follow strict rules for currency creation. He understands that the rules are only as good as the people running the system follow them. He understands that those running the system come under pressure from political leaders to relax the rules at times. He points out they can do this if you use gold too, so people have to follow rules for them to work in any system.

- everyone inside the system does not hate gold. If you read Dr. Coats papers he talks about the history of the gold standard and makes it clear his goal is to create a stable currency as did exist for a time under a gold standard. The people I have talked to inside the system just believe that a modern system can use other means to provide stability to the currency aside from just pegging it strictly to gold. See Dr. Coats comments on that above. From what I have seen this topic is debated within the system with people from various viewpoints. But most inside the system would agree that a gold standard as used in the past is not necessary today. They would view it more as a last resort if all else fails.This will continue to be a topic of debate and gold standard advocates will continue to argue their case. That's a good thing. Open debate and discussion is always a good thing. If the current system does fail, the public will be more open to hearing what gold advocates have to say. Therefore, it behooves those running the system to prevent failure to maintain public trust. A motivation to prevent failure is a good thing, even if that motivation is just to avoid being blamed.

-what I think I have learned is the most important ingredient in any monetary system is that the general public has trust and confidence in the currency and the system. If you have that, stability is much more likely. If those running the system abuse the currency too much for too long, it will eventually fail and public confidence has to be restored one way or another. If gold accomplishes that, then gold might be used. If a basket of goods can accomplish it, then that could work too. At the end of the day, it's all about public confidence and whatever it takes to restore it.I believe people inside the system do understand this.

-please note that at this time Dr. Coats does not have feedback on his proposal from IMF, BIS etc. This does not mean it will not go forward. It does once again illustrate that things tend to move slowly. This is something I have definitely learned. Global institutions simply do not move quickly unless they are forced to by a crisis. I know for sure that the idea of a global reserve currency has been discussed. I know that modern forms of technology (not Bitcoin or Blockchain) that could implement such a currency have been discussed. What this means is that these tools are known to be available inside the system. Whether they are used any time soon is a different question. To get a global reserve currency you have to have a lot of global cooperation from a lot of nations and organizations. The governments and organizations tend to be somewhat bureaucratic and political.This tends to inhibit change. It does not mean change will not happen, it just means the timetable is not predictable.

-I have stated here on the blog that I believe it is possible that in the future we could see a global reserve currency that is based on modern technology that everyone could use. After learning more from Dr. Coats, I remain convinced that this is possible in the future. Another crisis like Jim Rickards is predicting could speed up the process.

note to readers:  a thank you to Willem Middelkoop for a retweet on his twitter feed

Click here to see - Dr. Coats new article with co-author Dongsheng Di (Renmin University of China).   

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