"There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved."
- Ludwig von Mises

Thursday, February 17, 2011

On The Road To A Global Currency: The EU Throws its Hat in the Ring

Euractiv.com reports today:

EU to Back IMF-Led Plan to Rival US Dollar

A little background here for those that are not familiar with the Special Drawing Rights (SDR) - from the article:
The value of an SDR is derived from a basket of currencies, specifically, a fixed amount of Japanese yen, US dollars, British pounds and euros. 
Each year, the International Monetary Fund (IMF) decides which currencies enter the basket, and at what weight. At last count, there were approximately $308 billion-worth of SDRs.

In late March 2009, Zhou Xiaochuan, governor of the People's Bank of China, proposed using Special Drawing Rights as a worldwide reserve currency to replace the US dollar.
The advantage of SDRs is that they represent the global economy better than the dollar, which is prone to fluctuations in the US economy and US policy. Advocates claim that pricing oil in SDRs would prevent oil prices from spiking.  
The article continues:

At a meeting today (17 February) in Paris, finance ministers preparing for the G20 reunion later this year will consider adding the Chinese yuan to a basket of reserve currencies to rival the dominance of the dollar, according to an internal paper seen by EurActiv...
The economic argument for using Special Drawing Rights (SDRs) as currency reserves is that they could give countries a more stable financial position because they are based on a pool of currencies and therefore less likely to be affected by fluctuations in the US economy. By exchanging US dollars for SDRs, for example, governments can help insulate their foreign reserves from declining US interest rates.  
The EU appears to be following the lead of International Monetary Fund (IMF) Chief Dominique Strauss Kahn, who last week endorsed including the Chinese yuan in the SDR basket to stabilise the global system and to reduce the dominance of the dollar as a reserve currency. 
"Over time, there may also be a role for the SDR to contribute to a more stable international monetary system," Kahn said. 
The EU paper said it would explore whether "a limited number of currencies" of important countries could be added to the basket "to reflect global economic realities". 
French President Nicolas Sarkozy is the EU's most vocal supporter of adding the yuan and currently holds the presidency of this year's G20 rounds. 
Russian President Dmitry Medvedev said the currencies of the developing nations of Brazil, Russia, India and China should be included, while US President Barack Obama's administration said it could support an expansion "over time".  
SDRs have been a controversial subject since their creation in 1969, but in recent years have won the support of emerging economies like China, which hold trillions of dollars in its foreign exchange reserves.
A few things that stick out for me:

First is the push by emerging countries such as Russia and China to be included.  This may sound like global cooperation, but keep in mind that it was just last year when the currency wars were brewing and the G20 meetings were hopeless in providing a solution to the currency devaulation game that has been going on.  How can these same countries ultimately agree on what share of the new SDR will reflect their currency?

Second, the EU is spearheading this as a challenge to the US Dollar and continued US Dollar debasement.  But what of the status of the EU and its sovereign bond market?  Does the EU actually believe that austerity will allow the periphery countries to pay off their enormous debts?  Do EU leaders actually know how a debt-based monetary system works?  Do EU leaders understand that in international trade, one nation can not have a trade surplus unless another nation has a trade deficit?  Thus in a regional market such as the EU, in which most trade is conducted within - it is nearly mathematically impossible for all member countries to have a trade surplus at the same time!

Finally, notice how US President Obama said the US could support an expansion of the SDR "over time."  That's like telling your fiancĂ©e that we'll get engaged "over time."  You can't get more noncommittal than that!

I just don't see the US committing to an SDR.  Publicly, it may play along, but ultimately, the US has too much to lose.  But not that the current system is sustainable either.

Just last year, the Central Bankers of the world met for a "High-Level Conference" on the international monetary system.  The event was co-hosted by the Swiss National Bank (SNB) and the IMF.  The opening remarks by Philipp Hildebrand, Chairman of the SNB illustrated the dilemma the world faces by mostly transacting in one nation's currency, the US Dollar:
II. The problem

Arguably, much of the debate surrounding the international monetary system boils down to the following question: how sustainable is an international monetary regime, in which one national currency serves as the international reserve asset? Over the past few decades, this question has been examined under different perspectives. 
A first perspective was the so-called “Triffin dilemma”, discussed in the context of the Bretton Woods fixed exchange rate regime. This discussion highlighted that increasing indebtedness of the reserve-issuing country would in time undermine the very confidence that forms the basis for the reserve asset status.

A second perspective refers to the alleged “exorbitant privilege” of the reserve-issuing country. It highlights the asymmetry in the adjustment to shocks, as the reserve-issuing country has the privilege of not being under much pressure to adjust to current account deficits, at least over the short and medium term. It is worth noting that part of Keynes’ goal in setting up the IMF was to try to create symmetry between the need to adjust for both deficit and surplus countries.

More recently, the question appeared under the perspective of global imbalances. This discussion highlights that current account surplus countries can forego, at least temporarily, the required adjustment by accumulating international reserves instead. The sustainability of these imbalances, and the extent to which they have contributed to the recent global financial crisis, is still under discussion.


In conclusion, yes the world faces a crisis of sustainability by having the world's reserve currency issued by one nation.  In order for the world economy to grow, that nation needs to export its currency, which gives it an advantage - it gets to disproportionately consume the world's economic output.  Obviously as the trade deficit grows, government spending too, needs to grow, to maintain growth in the domestic economy.  This system can not last forever.

But will the US succumb to the SDR and lose this "exorbitant privilege" of consuming the world's economic output?  And what does that mean for US National Security when the current system effectively makes the rest of the world "finance" the US Military?  Is the US willing to lose that?

Can the SDR even work if the major underlying currencies such as the Euro, the US Dollar, the Yen and the Pound all have fiscal issues of their own?  Who gets to devalue their currency first, or the most, to pay off or at least manage their existing debt loads?

There are no easy answers.  Forty some years ago, the world went off a gold standard and entered a paper standard.  With the proliferation of computers, we are now in the electronic fiat standard where money is conjured up simply with computer keystrokes.  Imbalances thus intensify.  As this current system nears its end with unsustainable debt loads and unsustainable global trade imbalances, can a super sovereign electronic "virtual" fiat standard really cure what ills us?  Is this monetary evolution, or a desperate attempt at averting or delaying a collapse?

Once again, it seems to me we are putting off the inevitable, while creating the circumstances for a larger, more catastrophic collapse in the future.  The private banking system collapsed, saved only by governments taking on those debts.  And now governments find themselves increasingly fiscally trapped.  To elevate this sickness of debt and over-issuance of virtual debt-backed money onto a super-sovereign IMF/SDR system to me seems unlikely to be successful.  It requires the cooperation of many competing nations, in a world of limited resources, and conflicting geopolitics.  Once again, the Central Bankers of the world and Finance Ministers of the world are creating the circumstances for a tragic collapse.

I'll quote Austrian Economist von Mises once again:
"There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansionor later as a final and total catastrophe of the currency system involved."
The world's Central Bankers and Finance Ministers want to kick-up the problem once more - now onto the super-sovereign level.  Can anyone blame them?  To end the global credit expansion would push the world into an immediate global depression.   But they may soon find out when conflicts over the components of the SDR arise, and they have no more "solutions" left.  Reality, unfortunately, can only be delayed for so long.


Dave Narby said...

...I thought the Euro was supposedly designed to replace the USD? Now the SDR will replace the USD?

(Cue debt Jubilee followed by international "reference point" for savings in 3... 2...)

Misthos said...


Geopolitically, the EU has never meaningfully stood up to the US. At best, they tried to give the world an alternative to the Dollar.

But the way they went about creating the Euro has been a disaster. So the best Europe can do is to accommodate. They are not in a position of strength - not monetarily or militarily.

Russia and China are being more forceful, and the US is increasingly on the defensive.

All the while, the debt and imbalances grow. Just in from Bloomberg, French Finance Minister Lagarde points out the issues:

“We have a China that saves and exports, a Europe that consumes and grows slowly and a U.S. that consumes and borrows,” Lagarde said in a speech today in Paris. “We have to consider whether we can carry on like that.”

No, we can't carry on like that. But is there a global political will to correct this? I don't see it. The issue will resolve itself, as you say, debt Jubilee... and all the unintended consequences that come with that.

"reference point for savings" I like that. Looks like China and Russia are trying their best to hoard some of that "reference point for savings."

The EU and the US have enough gold, so they will carry on with paper solutions until they no longer can't. Russia and China are playing catch up in the meanwhile.

Dave Narby said...

Just in from Bloomberg, French Finance Minister Lagarde points out the issues:

“We have a China that saves and exports, a Europe that consumes and grows slowly and a U.S. that consumes and borrows,” Lagarde said in a speech today in Paris. “We have to consider whether we can carry on like that.”

More accurately, that would be a China that accumulates FRNs, a Europe that has one major productive country (Germany) and spectrum of coattail-riders with varying degrees of bureacratic 'surplus', and a U.S. consumes and borrows, but is the only thing keeping Russia from re-encroaching on Europe.

What a clusterf*ck.

The more I look at it, the more I fear it is liable to be disorderly before it resolves...