Peterson Institute publications
The Peterson Institute for International Economics is a private, nonprofit, nonpartisan
research institution devoted to the study of international economic policy. More › ›
RSS News Feed Search

Op-ed

Objections Do Not Invalidate Substitution Account Benefits

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.


RELATED LINKS

Policy Brief 13-29: Estimates of Fundamental Equilibrium Exchange Rates, November 2013 November 2013

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? October 2012
Revised August 2013

Policy Brief 12-19: Combating Widespread Currency Manipulation July 2012

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

Op-ed: Taxing China's Assets: How to Increase US Employment Without Launching a Trade War April 25, 2011

Op-ed: Why the World Needs Three Global Currencies February 15, 2011

Policy Brief 10-24: The Central Banker's Case for Doing More October 2010

Policy Brief 10-26: Currency Wars? November 2010

Testimony: Correcting the Chinese Exchange Rate September 15, 2010

Op-ed: New Imbalances Will Threaten Global Recovery June 10, 2010

Book: The Future of China's Exchange Rate Policy July 2009

Book: Debating China's Exchange Rate Policy April 2008

Article: The Dollar and the Deficits: How Washington Can Prevent the Next Crisis November 2009

Policy Brief 09-21: The Future of the Dollar September 2009

Policy Brief 07-4: Global Imbalances: Time for Action March 2007

Working Paper 11-14: Renminbi Rules: The Conditional Imminence of the Reserve Currency Transition September 2011

Peterson Perspective: Legislation to Sanction China: Will It Work? October 7, 2011

Book: China's Rise: Challenges and Opportunities (hardcover) September 2008