Download 3d_Dong He presentation_10 Dec (Bob paper)

Conference on
The BRICS & Asia, Currency Internationalization,
and International Monetary Reform
Hong Kong, 10-11 December 2012
Comment on “Reforming the international
monetary system in the 1970s and 2000s: would
an SDR substitution account have worked” by
Robert McCauley and Catherine Schenk
Dong HE (何東)
Executive Director (Research), Hong Kong Monetary Authority
Director, Hong Kong Institute for Monetary Research
What does the paper do?

An archive based account of the political economy of
the SDR Substitution Account proposal

Simulations of the solvency of the Account using
historical observations of SDR interest rates and US
treasury yields of bills, notes and bonds

Present a somewhat “skeptical” view on the proposal,
in contrast to Kenen, Bergsten, and others
2
A quibble

A more comprehensive simulation exercise would call
for a stochastic approach, deriving a probability
distribution of the solvency of the Account

A stochastic simulation would make issues such as the
initial conditions (e.g., the start date of the Account)
less a problem in assessing the feasibility/sustainability
of the Account
3
Broader and more fundamental questions

What is the nature of reserve currency issuance? Does the
“Triffin Dilemma” generally hold?

What does that tell about the future of the SDR as a global
reserve asset?

In principle, what would make an SDR substitution account
work?
4
The nature of reserve currency issuance

A reserve currency country plays the role of a bank to
the rest of the world: it provides a liquidity service by
issuing short-term liabilities that non-residents would
use for international trade and investment

But to prevent this process from becoming a Ponzi
scheme, it also needs to invest in other countries,
perhaps in less liquid forms and with longer maturity,
such as foreign direct investments

In other words, issuing reserve currency is a process of
financial intermediation through the international
balance sheet of the reserve currency country
5
The Triffin Dilemma

In its original and narrow sense, the Triffin Dilemma points to
a potentially explosive path of reserve currency issuance:
short-term liabilities of the reserve issuing country grows
infinitely against the backing of a stagnant stock of gold. This
would cause a run on the currency, particularly if the shortterm liabilities were caused by current account deficits

A main problem with Triffin’s arguments was that he ignored
other assets that the United States had on its international
balance sheet, i.e. its claims against non-residents, which were
making good returns to finance its short-term liabilities

In a broader perspective, the Triffin Dilemma points to an
inherent conflict: domestic policy objectives of the major
reserve currency country overrides its obligations to maintain
global monetary and financial stability
6
Implications for the SDR?

The issuance of SDR, which has to be of a much larger scale
than ever envisaged to be a meaningful global reserve asset,
needs to be backed by yield-enhancing claims on the asset side
of the balance sheet

The SDR issuance process needs to be a maturity transformation
process

In other words, the SDR issuer has to become more like a bank
or a credit union

It is thus not surprising that McCauley and Schenk find that
“basing the Treasury’s dollar interest payments to the
Substitution Account on the 20-year bond yield would have done
wonders for the solvency of the scheme”
7
Would an SDR substitution account in
principle work?

Yes, if such an account is managed actively and
professionally as a mutual fund

The yield on the SDR liabilities may need to be contingent
on the performance of the fund

But this would still serve the original purpose of the
substitution account: a diversification from the risk of a
persistent depreciation of the US dollar
8
End of discussion
Thank you for your attention!