HONG KONG – As the risk of a US-China trade war mounts, creating a geopolitically neutral and fair monetary system has become increasingly urgent. The shift from a unipolar to a multipolar world order has not been particularly orderly. Instead, it has produced a kind of monetary non-system that depends on a debt-driven, dollar-based model that is too pro-cyclical, fragile, and potentially biased to support the management of trade conflict.
At the root of the problem are the structural trade and current-account imbalances that arise from the so-called Triffin dilemma: in order to meet global demand for the US dollar as a reserve currency, the United States must run persistent current-account deficits with the rest of the world. Last year, that deficit reached $474 billion, or 2.4% of US GDP.
To be sure, the guarantee that the US, as the issuer of the dominant international reserve currency, can acquire low-cost funding for its fiscal deficit and national debt amounts to what former French President Valéry Giscard d’Estaing famously called America’s “exorbitant privilege.” But that privilege can erode the country’s fiscal discipline, as it has in recent years, resulting in high federal deficits ($833 billion, or 4.2% of GDP, in2018) and growing federal debt ($21 trillion, or 104% of GDP, as of March).
The policies favored by US President Donald Trump’s administration exacerbate this tendency. Recent tax cuts and increased military spending have led the International Monetary Fund to estimate that the US international investment position will deteriorate in the coming years, with net liabilities reaching 50% of GDP by 2022.
Moreover, Trump’s threats of trade and currency wars are fueling fears that the US dollar could become a weapon in geopolitical disputes. Such a step would trigger immense volatility throughout the international monetary system, throwing many economies – such as those that link their currencies to the US dollar or hold a large volume of dollar reserves – into crisis.
Yet the SDR is not used widely enough to serve as a major international reserve currency. According to a Palais Royal Initiative report, a key way to raise the SDR’s global standing is through “regular allocations of SDRs under appropriate safeguards” or even allocations “in exceptional circumstances.” The report also calls for the IMF to work with the private sector “to explore ways in which the SDR could be more widely used in private transactions.”
A key hurdle for the SDR has always been the geopolitical interests and priorities of the reserve-issuing central banks (not just the US, but also the eurozone, China, Japan, and the United Kingdom). But the advent of cryptocurrencies may offer another way: the private sector can work directly with central banks to create a digital SDR to use as a unit of account and store of value.
Of course, to enable a gradual shift from the US dollar to an e-SDR as the dominant international reserve currency, a sufficiently large e-SDR-denominated money market would need to be created. To that end, a politically neutral body, owned by the private sector or central banks, should be established to issue the asset. Participating central banks and asset managers would then have to swap their reserve-currency holdings for e-SDRs.
Another imperative would be to create an e-SDR-denominated debt market, which would appeal to countries that want to avoid getting caught in the crossfire between reserve-issuing countries. Multinational firms and regional and international financial institutions should provide the needed supply of assets. On the demand side, e-SDR-denominated long-term bank debts could be used by pension funds, insurance companies, and sovereign-wealth funds.
The e-SDR-denominated debt market would even be good for all reserve currencies – except the US dollar – as their weight in determining the asset’s value exceeds their current shares in foreign-exchange markets. In the longer term, the e-SDR’s rise could put added pressure on the US to rein in its spending.
Andrew Sheng, Distinguished Fellow of the Asia Global Institute at the University of Hong Kong and member of the UNEP Advisory Council on Sustainable Finance.
Xiao Geng, President of the Hong Kong Institution for International Finance, is a professor at the University of Hong Kong.
Copyright: Project Syndicate.