by C. Fred Bergsten, Peterson Institute for International Economics
Letter to the editor in the Financial Times in response to letter
by International Monetary Fund (IMF) historian James M. Boughton
December 28, 2007
© Financial Times
I was delighted that the eminent International Monetary Fund (IMF) historian James Boughton, in his letter of December 14, 2007, viewed my proposal for a substitution account (“How to Solve the Problem of the Dollar,” Financial Times, December 11, 2007) as “an excellent idea” that “could be part of the solution” to the present dilemma whereby many official institutions desire to diversify out of dollars but no other currencies want to receive the corresponding inflows.
Dr. Boughton raises two important questions about the idea. He argues that “someone has to absorb the exchange risk that the central banks are shedding” but this is in fact not essential. The special drawing rights (SDR) claims of depositors would mainly be used, if at all, via transfers to other account members. Even if the deposited dollars depreciated further, it is inconceivable that the account would be unable to meet legitimate requests for residual redemption. The only possible contingency requiring such “backing” is liquidation of the account, an even more remote prospect. In any event, Dr. Boughton’s own definitive history of the Fund reminds us that a substitution account, if it had been set up in 1980 when previously considered, would have made huge profits for its first five years that would have kept it whole for at least two decades.
If the IMF membership nevertheless insisted on “backing,” the IMF’s gold hoard of over $80 billion provides a ready resource. The objective of a substitution account is to preserve stability for the international monetary system by avoiding disruptive currency gyrations and major new misalignments. Hence it is perfectly appropriate to use a systemic asset, such as Fund gold, to support the arrangement. This idea was proposed by IMF Managing Director Jacques de Larosière, and considered seriously, when the account was actively debated in response to the last major period of dollar diversification in 1979–80.
The second key issue is the liquidity of claims on the account. Like SDRs themselves, they would be fully usable to finance external deficits and transferable to all participants in the scheme, a number of other approved holders, and back to the account itself. The absence of a private SDR market that would permit instantaneous liquidation is in fact a virtue of the scheme, because it reduces the risk of systemic instability, and irrelevant in any event for the massive dollar holders that would still have huge amounts of fully liquid assets after making deposits at the account. The benefits of diversified currency risk and market interest rates, along with greater systemic stability, would surely outweigh any liquidity disadvantage in the calculations of IMF members as they contemplate creating such an account and participating in it.
Policy Brief 14-16: Estimates of Fundamental Equilibrium Exchange Rates, May 2014 May 2014
Policy Brief 14-17: Alternatives to Currency Manipulation: What Switzerland, Singapore, and Hong Kong Can Do June 2014
Policy Brief 13-28: Stabilizing Properties of Flexible Exchange Rates: Evidence from the Global Financial Crisis November 2013
Op-ed: Unconventional Monetary Policy: Don't Shoot the Messenger November 14, 2013
Op-ed: Misconceptions About Fed's Bond Buying September 2, 2013
Working Paper 13-2: The Elephant Hiding in the Room: Currency Intervention and Trade Imbalances March 2013
Policy Brief 12-25: Currency Manipulation, the US Economy, and the Global Economic Order December 2012
Working Paper 12-19: The Renminbi Bloc Is Here: Asia Down, Rest of the World to Go?
Revised August 2013
Policy Brief 12-7: Projecting China's Current Account Surplus April 2012
Working Paper 12-4: Spillover Effects of Exchange Rates: A Study of the Renminbi March 2012
Book: Flexible Exchange Rates for a Stable World Economy October 2011
Policy Brief 10-24: The Central Banker's Case for Doing More October 2010
Policy Brief 10-26: Currency Wars? November 2010
Book: Debating China's Exchange Rate Policy April 2008