Calls for the end of the US dollar supremacy are increasing. Because most currencies are not fully convertible, an asymmetry arises between each country’s real economy and the monetary one. And the Federal Reserve is unlikely to subordinate its national objectives to the needs of the international economy. Ousmène Jacques Mandeng writes that while the gains from currency internationalisation could be significant, the potential costs of transition would be large.
Calls for reforming the international monetary system seem to be growing louder. Last week, the summit of the BRICS, a group of world economies so far including Brazil, Russia, India, China and South Africa, stressed the importance of using local currencies in international trade and financial transactions. Recent initiatives also include the New Development Bank to possibly explore a new BRICS currency; mBridge*, the BIS project to advance use of local currencies in international payments; China’s long-standing aim for renminbi internationalisation; and the objective of greater strategic autonomy by the European Union. The ideas are not new. In the past they failed because of an unwillingness to assume the costs of transition.
The initiatives are driven in large part by some motivation to reduce reliance on the US dollar. The dominance of the dollar is an outcome of the system of fixed exchange rates that was established with the IMF at the Bretton Woods Conference in 1944. Under the system, all currencies were pegged to the dollar at a fixed exchange rate while the dollar was convertible into gold. Shortly after Bretton Woods, concerns about the arrangement could be heard. Opposition to the arrangement in the British Parliament was cited stating: “The most impudent thing is that it makes the dollar the supreme international currency” (FT, 25 September 1944).
The dominance of the dollar survived the collapse of the system in the early 1970s. It has for some time been seen as a problem for the international economy: “The Western world was not willing to live with a system dictated by the US,” US treasury secretary Connally was quoted admitting (FT, 29 May 1971).
Fifty years ago in 1973, there was hope that a major initiative by the Committee of Twenty, the most ambitious to date, would succeed with a grand reform. At the time the goal was to replace the dollar as the anchor of the system with the Special Drawing Rights (SDRs) of the International Monetary Fund (IMF).
The Committee of Twenty eventually failed. It was mostly because countries were not prepared to assume the cost of a possible devaluation of the SDR relative to the dollar. Plans for an IMF substitution account, by which central bank foreign exchange reserves in dollars would be exchanged for SDRs, were similarly unsuccessful as countries were unwilling to shoulder the exchange rate risk.
The main advantage of using a national currency in international transactions is to reduce transaction costs related to foreign exchange risks. This is why many countries want to see the internationalisation of their currencies. It is not an option for all countries, amid the importance of network effects, and only the largest ones will likely be able to succeed.
While emerging markets represent about half of world GDP, their currencies play no significant role in international payments. It produces an important and potentially destabilising asymmetry between the real and the monetary economies. The network effects and hence advantages of using a single currency are most likely outweighed by the disadvantages of depending on the direction of monetary policies of a single country. The US Federal Reserve is very unlikely to subordinate its national policy objectives to the needs of the international economy.
To make diversification work today, countries will face similar choices as those of the past. One country or a group of countries may need to be ready to subsidise a transition towards a more multi-polar international monetary system. This could be done by being willing to make markets in its own currency with the readiness to absorb possible exchange rate losses and de facto produce a redenomination of its foreign currency reserves. It would also require granting other countries relatively unencumbered access to its currencies and related capital markets. Hedging instruments will need to be available to allow others to manage their foreign exchange exposures.
Central bank digital currencies (CBDC) have often been associated with recent initiatives to promote use of alternative currencies. CBDC may render currencies relatively more attractive by offering new functionalities and access but per se are unlikely to be a sufficient condition. Many old-fashioned arguments that support interest in a given currency will probably prevail such as its stability relative to a set benchmark. Yet, greater stability itself is also likely to be a result of international currency usage.
Fifty years ago, the willingness to change seemed universal. Even the US wanted to support a transition towards the SDR. The euro is the most significant outcome of those attempts. Today, efforts seem more national. This will likely constrain potential successes.
The gains from currency internationalisation are considered to be significant. With about US$150 trillion in annual international payments and growing rapidly, the potential costs of transition could be large. Any major international currency initiative should therefore be carried by countries with deep pockets between the central bank and to some extent commercial banks. But a signal in that direction may indeed be the start of a credible reform.
