Sunday, March 6, 2016

Followup: IMF SDR: An Emerging Global Currency? - Dr. Coats Answers a Blog Reader's Questions

One of the goals of this blog is provide the best quality information we can find for readers representing a variety of credible viewpoints. The article we published this weekend with the video presentation on the potential future for the SDR has generated a lot of reader interest and some great questions. One reader sent me three questions he would like to ask Dr. Coats about the video. I asked Dr. Coats if he would be willing to provide answers to the questions and he was happy to do so. 

Below I have posted the questions sent in by email by reader John Y. Below that is Dr. Coats email reply he sent me listing the three questions and his answer to each one. This is great information for readers here and it helps this blog serve the purpose I intended for it. A big thank you to both reader John Y. and Dr. Coats for the questions and the answers!

First, here are the questions as I received them in the email from reader John Y:

"Larry, thank you for posting the video on the SDR discussion at the IMF. I watched it last night and found it very interesting. I'm hoping you can help clear up something that Dr. Coats said during the discussion. Around the 42:02 mark, the moderator asks whether the reforms needed to implement the SDR as a global reserve currency would tie the Feds hands in terms of monetary policy. Dr. Coats responded (42:18) that this would happen "only if the Fed, in its great wisdom would decide to fix the US dollar to the SDR." Do you think Dr. Coats was sincere and honestly meant the Fed should peg the dollar to the SDR or that this was more of a tongue-in-cheek, sarcastic respond? At first I thought he was sincere, but after re-watching it a few times, I'm thinking he was being sarcastic. What do you think? 

The reason I'm asking, is because if he was sincere then I think this would come into conflict with the Impossible Trinity concept, and I would like to ask him about this conflict. In case you're not familiar with the Impossible Trinity, it basically states that a country can't have free capital controls, an independent monetary policy, and an unpegged, free-floating exchange rate all at the same time. Long-term, you can only have 2 of the 3."

This is the second email with the last two questions:

"Along those lines,two other questions arose from watching the video. If you think they're worth passing along and/or posting, then please do so.
  1. During the initial discussion of the SDR and why it should take on the role of global reserve currency instead of a national currency, I think both Dr. Coats and Dr. Krueger (sp?) were alluding to the idea of Triffin's Dilemma. Is that correct? Does this paradox help support their reasoning for why the SDR should take on a larger role in the international financial system?
  2. When Dr. Coats talked about private SDRs, how exactly does a bank set them up? So if I'm a bank and want to start issuing SDRs, what are the steps that I need to setup in order to do so? Do I start accumulating reserves (assets) in whatever currencies (US Dollar, Pounds, Euros, Yen, Yuan) that make up the SDR basket and then loan out SDRs (liabilities)?"

Below is the reply Dr. Coats sent me with the three questions listed and his answer to each one:

Question: Should the U.S. fix its exchange rate to the Real SDR and would that violate the impossible trinity?

Answer:  I have attempted to lay out gradual steps toward what I think is the optimal international monetary system. Replacing national currencies (the U.S. dollar) in international reserves with an internationally issued currency (the SDR) would be a very major accomplishment.  National central banks would be free to fix the exchange rate of their currency to the SDR or not.  However, the fully optimal system in my view is one in which all central banks fix the exchange rates of their currencies to the SDR. This would essentially be the one world currency we had under the gold standard of the late nineteenth century.  So yes, I would like to see the U.S. dollar fixed to the SDR.  That would mean (as indicated by the impossible trinity, which the questioner misstated) that the U.S. could not have an independent monetary policy.  The money supply would always be what ever the public wanted to hold at the official value of the SDR following currency board rules.

Question: Is there something similar to the Triffin Dilemma supporting the argument for replacing a national currency in international reserve with an international one?

Answer:  The Triffin Dilemma was that under the gold standard, when U.S. dollars were redeemable for a fixed amount of gold, increases in international holdings of dollars could grow so large that its redeemability for gold would loose credibility, causing something like a run on the bank.  The dollar is no longer redeemable for gold or anything else at a fixed price, but as international dollar reserves are generally held as U.S. treasury securities, the size of the U.S. government’s public debt could grow so large that foreign owners of that debt could loose confidence in the ability of the U.S. government to repay it (or even service it) thus causing them to dump the dollar.  This is similar to the Triffin Dilemma, which could be avoiding using an internationally issued currency (SDR).

Question: How would a bank create private SDRs?  What are the steps?

Answer: Where no private SDRs exist, a bank customer (e.g. the AIIB) would ask its bank to credit the SDR equivalent of a dollar (Euro or whatever) deposit to a new SDR deposit account of the customer.  The bank would determine the SDR amount applying the official SDR exchange rate to the currency presented and record that amount in the customer’s SDR account.  That creates SDR deposits.  The next issue is what assets would the bank keep against these SDR deposit liabilities?  It could hold assets (loans, securities, etc.) denominated in the national currency the customer brought if it was prepared to accept the exchange rate risk of a mismatch between its assets and liabilities (a so called open FX position).  Or it could balance its exposure by converting the dollars into the appropriate amount of each of the five currencies in the current SDR valuation basket.  Or if there are financial assets denominated in SDRs it could acquire and hold those, or denominate its loans in SDRs etc.

No comments:

Post a Comment