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Currency Wars:
Global Money in 2010
Jeffrey Frankel
Harpel Professor of Capital Formation & Growth,
Harvard University
Macquarie Securities
Boston, December 8, 2010
1
Currency Wars Chronology, Fall 2010

September 15
Japan buys $20 b, for ¥,
• after a 6-year absence from FX markets;
• thereby joining Switzerland, the other floater to have
appreciated in 2008-09 GFC and to have fought it by
FX intervention.
2
Currency Wars chronology, continued
September 27:
warning from Brazil’s Finance
Minister Guido Mantega:
“We’re in the midst of
an international currency war,
a general weakening of currency. This threatens
us because it takes away our competitiveness.”
 I.e., countries everywhere are trying
to push down the value of their currencies,
to gain exports & employment,

• a goal that is not globally consistent.
3
Currency Wars chronology,

continued
Renewed flows to emerging markets in 2010
have met with $ purchases in FX intervention
• Brazil, Korea, Thailand, India & others
must manage inflows:



Appreciation
Buying $ to prevent appreciation
Capital controls?
4
Currency Wars chronology,
continued
October 15:
U.S Treasury postpones semi-annual report to
Congress on currency manipulation

• although there has clearly been little appreciation of the
RMB since China announces more flexibility in June.
• (All a repeat of 2005.)
5
Currency Wars chronology,

continued
November
• After inflation rises to 4.4% in October,
China raises i & reserve requirements
and adopts new price controls.
• US core inflation falls to 0.6% for year,
the lowest since 1957.
• => fears of deflation trap.
6
Currency Wars chronology,
continued
• Nov. 17
As European sovereign debt crisis resurfaces
in Ireland, € hits 7-week low (1.3 $/€).
• Nov.20-21
Fed announces QE2 (signaled since August):



will purchase $600b.
Short-term market reaction: $ depreciates
Immediate attacks on Fed action -• Palin & conservatives: “debauching the currency”
• German & China: $ depreciation is a deliberate salvo in currency wars
7
The reactions of most
emerging markets show they learned two
lessons from the 1990s currency crises:

Advantages of holding forex reserves:
• Lower frequency & severity of crises.

Advantages of floating:
• Speculators don’t have a target to shoot at;
• Accommodate shocks;
• Discourage unhedged $ liabilities.


Such currency mismatch leads to bad balance sheet effects when
devaluation comes.
How did these lessons fare in the global crisis of 2008-09?
8
Reserves


Even though many developing & emerging market
countries described themselves as floating,
most took advantage of the boom of 2003-2008
to build up reserves to unheard of heights,
• in the aftermath of the crises of 1994-2001.

in contrast to past capital booms (1975-81, 1990-97).
9

When the 2008-09 global financial crisis hit,
• those countries that had taken advantage of
the 2003-08 boom to build up reserves did better.




Frankel & Saravelos (2010).
Aizenman (2009) and Obstfeld, Shambaugh & Taylor (2009)
Vs. Blanchard (2009) and Rose & Spiegel (2009)
This had also been the most common finding
in the many studies of Early Warning Indicators
in past emerging market crises.
10
EWIs: The variables that show up as the strongest
predictors of country crises in 83 studies are:
(i) reserves and (ii) currency overvaluation
0%
10%
20%
30%
40%
50%
60%
70%
Reserves
Real Exchange Rate
GDP
Credit
Current Account
Money Supply
Budget Balance
Exports or Imports
Inflation
Equity Returns
Real Interest Rate
Debt Profile
Terms of Trade
Political/Legal
Contagion
Capital Account
External Debt
% of studies where leading indicator was found to be
statistically signficant
(total studies = 83, covering 1950s-2009)
11
Source: Frankel & Saravelos (2010)
Best and Worst Performing Countries -- F&S (2010), Appendix 4
GDP Change, Q2 2008 to Q2 2009
Lithuania
Latvia
Ukraine
Estonia
Macao, China
Russian Federation
Bottom 10
Georgia
Mexico
Finland
Turkey
Australia
Poland
Argentina
Sri Lanka
Jordan
Indonesia
To p 10
Egypt, Arab Rep.
Morocco
64 countries in sample
India
China
-25%
-20%
-15%
-10%
-5%
0%
5%
12
10%
Table Appendix 6
Coefficients of Bivariate Regressions of Crisis Indicators on Each Independent Variable* (t-stat in parentheses)
bolded number indicates statistical signficance at 10% level or lower, dark er color shading equivalent to higher statistical significance
Currency
Market
Equity
Market
Recourse to
IMF
Industrial
Production
GDP
S ignif ic a nt a nd
C o ns is t e nt
S ign?^
Reserves (% GDP)
0.082
(2.52)
0.850
(1.6)
-1.020
(-1.92)
0.155
(2.22)
0.008
(0.27)
Yes
Reserves (% external debt)
-0.000
(-1.42)
0.000
(2.11)
-0.010
(-3.42)
0.000
(3.62)
0.000
(3.07)
Yes
Reserves (in months of imports)
0.002
(1.58)
0.103
(4.71)
-0.089
(-3.31)
0.006
(1.48)
0.001
(0.75)
Yes
M2 to Reserves
0.000
(0.14)
-0.026
(-3.81)
-0.067
(-1)
-0.001
(-2.46)
0.000
(1.44)
Yes
Short-term Debt (% of reserves)
-0.000
(-2.6)
-0.007
(-4.45)
0.000
(1.18)
-0.000
(-1.7)
-0.000
(-2.93)
Yes
REER (5-yr % rise)
-0.293
(-5.4)
-0.303
(-0.32)
0.889
(0.99)
-0.000
(-0.01)
-0.029
(-0.85)
REER (Dev. from 10-yr av)
-0.292
(-2.93)
-0.920
(-0.81)
0.671
(0.58)
-0.000
(-0.01)
-0.041
(-0.91)
GDP growth (2007, %)
0.003
(1.7)
0.078
(1.58)
0.039
(1.63)
0.010
(2.59)
-0.002
(-1.21)
GDP Growth (last 5 yrs)
0.002
(1.08)
0.118
(2.14)
0.052
(1.68)
0.009
(2.14)
-0.003
(-1.21)
GDP Growth (last 10 yrs)
0.005
(1.59)
0.087
(1.06)
0.042
(1.2)
0.016
(2.63)
-0.004
(-0.76)
GDP per capita (2007, constant 2000$)
-0.003
(-0.7)
-0.296
(-4.69)
-0.221
(-3.23)
-0.027
(-2.48)
-0.010
(-1.74)
Change in Credit (5-yr rise, % GDP)
-0.029
(-0.83)
-1.979
(-5.42)
0.139
(0.37)
-0.092
(-1.67)
-0.065
(-2.34)
Yes
Change in Credit (10-yr rise, % GDP)
-0.024
(-2.84)
-0.904
(-3.9)
-0.011
(-0.08)
-0.046
(-1.58)
-0.019
(-1.13)
Yes
Credit Depth of Information Index (higher=more)
-0.005
(-1.34)
-0.115
(-1.72)
0.009
(0.19)
0.006
(0.57)
-0.003
(-0.47)
Bank liquid reserves to bank assets ratio (%)
0.000
(1.52)
0.022
(1.51)
-0.000
(-13.97)
0.002
(2.34)
0.001
(2.58)
Yes
Current Account (% GDP)
0.001
(1.57)
0.032
(2.18)
-0.032
(-3.46)
0.000
(0.42)
0.000
(0.78)
Yes
Current Account, 5-yr Average (% GDP)
0.001
(1.31)
0.030
(1.66)
-0.032
(-2.76)
0.000
(0.53)
0.000
(0.42)
Current Account, 10-yr Average (% GDP)
0.000
(0.72)
0.034
(1.46)
-0.038
(-2.63)
0.000
(0.15)
0.001
(1.59)
Net National Savings (% GNI)
0.000
(0.9)
0.048
(4.5)
-0.020
(-1.88)
0.003
(2.42)
0.002
(2.92)
0.000
0.047
-0.028
0.003
0.002
F & Saravelos (2010): Bivariate
Independent Variable
R
E
S
E
R
V
E
S
R
E
E
R
G
D
P
C
R
E
D
I
T
C
U
R
R
E
N
T
A
C
C
O
U
N
T
Gross National Savings (% GDP)
Yes
13
Yes
Yes
Table Appendix 7
Coefficients of Regressions of Crisis Indicators on Each Independent Variable and GDP per Capita* (t-stat in parentheses)
bolded number indicates statistical signficance at 10% level or lower
F & Saravelos
(2010):
Multivariate
Exchange
Market
Pressure
Currency % Recourse to
Changes
IMF
(H208-H109
(SBA only)
Equity
%Chng
(Sep08Mar09)
Equity %
Chng
(H208H109)
S ignif ic a nt
a nd
C o ns is t e nt
S ign?^
Independent Variable
R
E
S
E
R
V
E
S
R
E
E
R
G
D
P
C
R
E
D
I
T
C
U
R
R
E
N
T
A
C
C
O
U
N
T
Reserves (% GDP)
0.164
(3.63)
0.087
(2.98)
-1.069
(-1.66)
0.011
(0.12)
0.010
(0.14)
Yes
Reserves (% external debt)
0.000
(1.06)
0.000
(1.1)
-0.006
(-2.29)
0.000
(1.81)
0.000
(2.65)
Yes
Reserves (in months of imports)
0.004
(2.25)
0.003
(1.95)
-0.119
(-3.01)
0.006
(1.32)
0.009
(2.32)
Yes
M2 to Reserves
0.000
(0.27)
0.000
(0.76)
-0.044
(-0.91)
0.000
(0.02)
-0.000
(-0.09)
Short-term Debt (% of reserves)
-0.000
(-1.97)
-0.000
(-4.22)
0.000
(2.13)
-0.001
(-2.89)
-0.001
(-3.11)
Yes
REER (5-yr % rise)
-0.440
(-5.55)
-0.210
(-3.19)
1.728
(2.15)
-0.182
(-1.24)
-0.185
(-1.61)
Yes
REER (Dev. from 10-yr av)
-0.475
(-3.96)
-0.230
(-2.47)
2.654
(2.56)
-0.316
(-1.71)
-0.316
(-2.1)
Yes
GDP growth (2007, %)
-0.000
(-0.2)
0.001
(0.94)
0.070
(2.58)
-0.001
(-0.1)
-0.007
(-0.71)
GDP Growth (last 5 yrs)
-0.003
(-0.81)
0.000
(0.26)
0.084
(2.4)
-0.003
(-0.26)
-0.014
(-1.15)
GDP Growth (last 10 yrs)
0.000
(0.14)
0.001
(0.43)
0.064
(1.66)
-0.012
(-0.67)
-0.020
(-1.12)
Change in Credit (5-yr rise, % GDP)
-0.021
(-0.36)
-0.035
(-0.98)
0.552
(1.02)
-0.274
(-2.97)
-0.248
(-4.13)
Change in Credit (10-yr rise, % GDP)
-0.017
(-0.93)
-0.011
(-1.05)
0.210
(1.03)
-0.089
(-1.65)
-0.089
(-2.35)
Credit Depth of Information Index (higher=more)
-0.008
(-1.06)
0.000
(0.05)
0.224
(2.4)
-0.006
(-0.37)
-0.018
(-1.33)
Bank liquid reserves to bank assets ratio (%)
0.000
(3.84)
0.000
(0.5)
-0.000
(-11.44)
-0.002
(-0.54)
-0.002
(-0.79)
Yes
Current Account (% GDP)
0.001
(1.48)
0.002
(2.7)
-0.023
(-2.09)
0.009
(3.84)
0.007
(3.95)
Yes
Current Account, 5-yr Average (% GDP)
0.000
(0.48)
0.001
(1.82)
-0.025
(-1.72)
0.007
(2.4)
0.006
(2.74)
Yes
Current Account, 10-yr Average (% GDP)
0.000
(0.14)
0.002
(1.39)
-0.035
(-2.11)
0.008
(2.21)
0.007
(2.44)
Yes
Net National Savings (% GNI)
0.002
(1.6)
0.001
(2.33)
-0.013
(-1.22)
0.006
(2.92)
0.004
(2.28)
Gross National Savings (% GDP)
0.003
(2.01)
0.001
(2.53)
-0.015
(-1.36)
0.008
(3.42)
0.006
(3.03)
Yes
14 Yes
Yes
Floating

Most medium-income Emerging Market
countries reacted to the currency crises of the
1990s by increasing exchange rate flexibility
• with the major exception of Eastern Europe.

The flexibility has helped.
15
Poland, the only continental EU member with a floating
exchange rate, was also the only one to escape
negative growth in the global recession of 2009
% change in GDP
Poland
Lithuania
Latvia
Estonia
Slovakia
Czech Republic
Hungary
2006
2007
2008
2009
2010
6.2 6.8 5.1 1.7 3.5f 7.8 9.8 2.9 -14.7 -0.6f 12.2 10.0 -4.2 -18.0 -3.5f 10.6 6.9 -5.1 -13.9 0.9f 8.5 10.6 6.2 -4.7 2.7f 6.8 6.1 2.5 -4.1 Source: Cezary Wójcik, 2010
1.6f Exchange Rate
Floating
(de facto)
Fixed
Fixed
Fixed
Euro
Flexible
16
Flexible
The Polish exchange rate increased by 35%.
Depreciation boosted net exports; contribution to GDP growth > 100%
4,7
Source:
Cezary Wójcik
28,0
4,5
zlotys / $
23,0
4,2
Contribution of Net X to GDP:
4,0
2009: 2,5
3,4
3,2
GDP growth rate:
3,7
3,5
3,4
18,0
1,7
kroon / $
Estonia
13,0
lats / $
Latvia
3,2
8,0
I
III
V
VII
IX
XI
I
III
V
VII
IX
XI
I
III
V
VII
IX
17
2008
2009
2010
Capital flows to emerging markets, especially Asia,
recovered quickly from the 2009 recession.
These countries again show big balance of payments surpluses
Goldman Sachs
18
Although China continues the most salient case,
Korea, Singapore & Taiwan are also
adding heavily to reserves.
GS Global ECS Research
19
Others, such as India & Malaysia, are currently
taking the inflows in the form of currency
appreciation, more than reserve accumulation.
more-managed floating
less-managed floating
(“more appreciation-friendly”)
GS Global ECS Research
20
In Latin America as well, inflows have returned,
reflected mostly as reserve accumulation in Peru,
but as appreciation in Chile & Colombia.
more-managed floating
less-managed floating
(“more appreciation-friendly”)
21
GS Global ECS Research
Is the currency war metaphor appropriate?

Fear of non-cooperative “competitive devaluation”
is an argument for fixed exchange rates
• rooted in the 1930s.
• That is why the architects of the post-war monetary order
chose fixed exchange rates
at Bretton Woods, NH, in 1944.

But it is now used to argue that China
should move from fixing to floating.
• US Congressmen don’t
care about regimes;
• they just want a stronger RMB vs. $.
22
Is the currency war metaphor applicable?



continued
Economic historians have decided
competitive devaluation under 1930s
conditions was not a problem after all.
True, countries couldn’t all devalue
against each other,
But they could and did all devalue against gold
• which worked to ease global monetary policy,

just what was needed.
23
Is the currency war metaphor applicable?

continued
The same is true today:
• The Fed’s QE2 won’t just raise the money supply in the US;
• it will also loosen globally,

to the extent that foreign central banks react by buying $
• to prevent their own currencies from appreciating.
• which is what much of the world needs.


For those who don’t need it, because they are already
in danger of overheating, they can allow appreciation,
and so calibrate however much expansion they want.
Multilateral cooperation is not necessary for this.
24
Indeed, the currency war critics
seem to have forgotten the point
of a global floating system:

In some places (US),
unemployment is high & inflation low,
• calling for easy monetary policy;

In other places (China, Brazil, India…),
economies are overheating,
• calling for tight monetary policy.

The point of a floating system is to accommodate
such inevitable macro divergences smoothly.

No international cooperation is needed.
25
Would this put unfair pressure on China
to choose between inflation,
if it continues to keep the RMB down,
and appreciation?
No.

Perhaps China can continue
to sterilize inflows awhile longer,
• e.g., raising bank reserve requirements.
• True, eventually it will have to give that up.


But there is nothing unfair about making China
choose between inflation and appreciation.
Monetary expansion by the US is perfectly legitimate
• especially at a time of deflation danger.
• If it puts pressure on China, that is far more clearly
within the “rules of the game” than threatening tariffs.
26
Is the currency war metaphor applicable? continued

Other kinds of international cooperation are needed;
• the 1930s currency war metaphors are not totally misplaced:

Currency war could turn into trade war
• if Congress follows through on legislation to impose (WTO-illegal)
tariffs on China as punishment for non-appreciation.
• Until now, the US & G20 have held the line on protectionism


compared to the milder recessions of 1991 & 2001,
let alone the Smoot Hawley tariff of 1930.
27
Ideally the US & China would reach agreement
on how to address current account imbalances:

China would take some responsibility
• to reallocate its economy away from
exclusive reliance on exports & manufacturing

toward domestic consumption & services,
• health, education, housing, environment, insurance & other services.
• How? By allowing the RMB to appreciate,
• but also by increasing domestic demand.

Meanwhile, the US would ideally also take responsibility.
• Even while prolonging expansionary policy this year,

including fiscal expansion designed with high bang-for-the-buck,
• the US should take steps today to lock
in a future return to fiscal responsibility,

e.g., by putting Social Security on a firm footing.
28
Will Unsustainable Current Account Deficits
Lead to the End of Dollar Hegemony?

Some argue the US current account
deficit is sustainable indefinitely.
• They believe that the US will continue to enjoy
its unique “exorbitant privilege,”


able to borrow unlimited amounts in its own currency
because it is the dominant international reserve asset.
29
“Bretton Woods II”

Dooley, Folkerts-Landau, & Garber (2003) :
• today’s system is a new Bretton Woods,

with Asia playing the role that Europe played
in the 1960s—buying up $ to prevent
their own currencies from appreciating.
• More provocatively:
China is piling up dollars
not because of myopic mercantilism,
but as part of an export-led development strategy
that is rational given China’s need to import workable
systems of finance & corporate governance.
30
My own view on Bretton Woods II:
•
•
The 1960s analogy is indeed apt,
but we are closer to 1971 than to 1944 or 1958.
•
Why did the BW system collapse in 1971?

The Triffin dilemma could have taken decades
to work itself out.

But the Johnson & Nixon
administrations accelerated
the process by fiscal & monetary expansion
(driven by the Vietnam War & Arthur Burns, respectively).

These policies produced: declining external balances,
$ devaluation, & the end of Bretton Woods.
31
There is no reason to expect better today:
1)
Capital mobility
is much higher now than in the 1960s.
2)
The US can no longer rely
on support of foreign central banks:

neither on economic grounds
(they are not now, as they were then,
organized into a cooperative framework where
each agrees explicitly to hold $ if the others do),

nor on political grounds
(these creditors are not the staunch allies
the US had in the 1960s).
32
The financial crisis caused a flight to quality
which evidently still means a flight to US $.

US Treasury bills in 2008-09 were more in demand
than ever, as reflected in very low interest rates.

The $ appreciated, rather than depreciating
as the “hard landing” scenario had predicted.

=> The day of reckoning had not yet arrived.

Chinese warnings (2009) may be turning point:
• Premier Wen worried US T bills will lose value.
• PBoC Gov. Zhou proposed
replacing $ as international
currency.
33
Multiple International
Reserve System

The € now exists as a rival to the $.

The ¥ & SF are also safe havens.

The SDR came back
from the dead in 2009.

Gold made a comeback as
an international reserve too.

Someday the RMB will join the roster.

= a multiple international reserve currency system.
34
The euro project is looking
far less successful than just a few years ago

Many predictions of euro skeptics have come true:
• Periphery countries and core countries have had trouble
reconciling asymmetric monetary needs.
• Euro members have not had enough labor mobility
or flexibility to make up for it.
• Efforts to prevent excessive debt & bailouts have failed:


The Stability & Growth Pact failed with members big & small.
The “No bailout clause” has failed with Greece.
35
Frankfurt & Brussels
made 3 mistakes regarding Greece

2002-09: Did not allow spreads to open up
between sovereign debt of Greece & Germany.

Winter 2010: Did not tell Greece to go to the IMF.
Preferred instead to “handle it internally.”

Still today: No “Plan B” to restructure Greek debt
(and save the bailout fund for more deserving banks & PIIGs).
36
Judging from spreads, 2001-07,
investors put zero odds on a default by Greece
or other Mediterranean countries
Council on Foreign Relations
37

Suddenly, in 2010, the Greek sovereign spread
shot up, exceeding 800% by June.

Even when the Greek crisis erupted,
leaders in Brussels & Frankfurt
seemed to view it as a black swan,
• instead of recognizing it as a close cousin
of the Argentine crisis of ten years earlier,

and many others in history,
• including among European countries.
38
Sovereign spreads for 5 euro countries
shot up in the 1st half of 2010
Creditworthiness: Some advanced economics
have fallen, as emerging markets have risen.
39
Sovereign debt worries
...
• As predicted, the sovereign debt crisis
in Europe is not going away.
• The big emerging market countries
are in much better shape,
• in an amazing & historic role reversal.
40
A remarkable role-reversal:
• Debt/GDP of the top 20 rich countries
(≈ 80%) is already twice that
of the top 20 emerging markets;
• and rising rapidly.
• By 2014 (at ≈ 120%), it could be triple.
41
Ratings for “Advanced Economies”
Ratings for “Emerging Economies”
42
43
Appendix:
Will the $ lose hegemony?
When does the “privilege” become “exorbitant?”



if it accrues solely because of size and history, without
the US having done anything to earn
the benefit by virtuous policies such as budget
discipline, price stability & a stable exchange rate.
Since 1973, the US has racked up $10 trillion
in debt and the $ has experienced a 30% loss
in value compared to other major currencies.
It seems unlikely that macroeconomic policy discipline
is what has earned the US its privilege !
44
Some argue that the privilege to incur $
liabilities has been earned in a different way:

Global savings glut

The US appropriately exploits its comparative advantage
in supplying high-quality assets to the rest of the world.
(Bernanke)
• “Intermediation rents…pay for the trade deficits.”
-- Caballero, Farhi & Gourinchas (2008)
• In one version, the US has been operating as the World’s
Venture Capitalist, accepting short-term liquid deposits and
making long-term or risky investments -- Gourinchas & Rey (2008).
• US supplies high-quality assets:
Cooper (2005); Forbes (2008); Ju & Wei (2008);
Hausmann & Sturzenegger (2006a, b);
Mendoza, Quadrini & Rios-Rull (2007a, b)…
45


The argument that the US offers assets of superior
quality, and so has earned the right to finance its
deficits, was undermined by the dysfunctionality
revealed in the financial crisis of 2007-08.
American financial institutions suffered a severe
loss of credibility (corporate governance, accounting
standards, rating agencies, derivatives, etc.),

How could sub-prime mortgages be
the superior type of assets that uniquely
merit the respect of the world’s investors?
46

But the events of 2008-09 also
undermined the opposing interpretation,
the unsustainability position:


Why no hard landing for the $, as long feared?
The $ appreciated after Lehman Brothers’
bankruptcy, & US T bill interest rates fell.

Clearly in 2008 the world still viewed
•
the US Treasury market as a safe haven and
•
the US $ as the premier international currency.
47
Though arguments about the unique high quality
of US private assets have been tarnished,
the idea of America as World Banker is still alive:
the $ is the world’s reserve currency,
by virtue of US size & history.


Is the $’s unique role
an eternal god-given constant?
Or will a sufficiently long record of deficits &
depreciation induce investors to turn elsewhere?
48
Historical precedent: £’s loss of premier
international currency status in 20th century

By 1919, US had passed UK in
1. output (1872)
2. trade (1914)
3. net international creditor position (1914-19)

Subsequently,
$ passed £ as #1 reserve currency (1940-45).
49
From the literature
on reserve currencies
Determinant:
Proxy:
1.
Size
GDP
2.
Depth of Fin.mkt.
FX turnover
3. Rate of return
inflation,
LR depreciation,
Exch. rate variance
50
From the literature, continued
Network externalities
=> Tipping
captured by:
1)
Inertia
lags
2)
Nonlinearity
in determinants
logistic functional form
or
dummy for leader GDP
51
Projection of $ vs €
as shares of central banks’ foreign exchange reserves:
a function of country size, financial market depth, & rate of return,
with parameters estimated on 1973-98 data.
1.0
Simulation assumes $ depreciation continues at 2001-04 rate.
USD
Chinn & Frankel
(2005)
0.8
0.6
0.4
0.2
0.0
birth
of €
DEM
EUR
This scenario showed €
overtaking $ as top international
reserve currency in 2022.
52
75 80 85 90 95 00 05 10 15 20 25 30 35 40
International Currency Roles
Table B
Adapted from Kenen
Function
of
money:
Store of
value
Medium
of
exchange
Unit of
account
Governments
Private actors
International reserve
holdings
Vehicle currency for
foreign exchange
intervention
Anchor for pegging
local currency
Currency substitution
(private dollarization)
Invoicing trade and
financial transactions
Denominating trade and
financial transactions
53

A multiple reserve currency system is inefficient,
in the same sense that barter is inefficient:
money was invented in the first place to cut down
on the transactions costs of exchange.

Nevertheless, if sound macro policies
in the leader country cannot be presumed,
the existence of competitor currencies gives
the rest of the world protection against the leader
exploiting its position by running up too much
debt and then inflating/depreciating it away.
54
Gold

Gold was seen as an anachronism just a few years ago:
• the world’s central banks were selling off their stocks.

Gold re-joined the world monetary system in 2009:
• The PBoC, RBI, & other Asian central banks
bought gold, to diversify their reserves.
• Even in advanced countries, central banks
appear to have stopped selling.
55
Special Drawing Rights






The SDR has made a surprising comeback as a potential
international money, from near-oblivion.
The G20 in 2009 decided to create new SDRs ($250b).
Shortly later, PBoC Gov. Zhou proposed replacing
the $ as lead international currency with the SDR.
The IMF is now borrowing in SDRs.
The proposal has been revived for an international
substitution account at the IMF, to extinguish an unwanted
$ overhang in exchange for SDRs.
The SDR has little chance of standing up as a competitor
to the € or ¥, let alone to the $.
Still, it is back in the world monetary system.
56

http://ksghome.harvard.edu/~jfrankel/index.htm
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