In 1944, the historic meeting on the international monetary system was held in Bretton Woods, New Hampshire. The British delegation was led by Lord Keynes, the foremost economic thinker of his day. The U.S. delegation was effectively led by Treasury adviser Harry Dexter White. Even though all the Allies attended the meeting, including China and India, it was essentially a debate between the declining superpower, Britain, and the rising superpower, the United States.

Keynes understood full well the problem that Britain faced as the issuer of sterling. Since Britain was running large current account deficits because of the two world wars, it was having a tough time maintaining sterling as the main reserve currency. By the end of the Second World War, the U.S. emerged as the dominant global power, since it ran large current account surpluses by supplying food and raw materials to Europe in exchange for gold. To avoid the Triffin dilemma, Keynes argued for the creation of a new international currency, called bancor that would not be related to the issue of a national reserve currency.

The Triffin dilemma is the problem that the issuer of the global reserve country had to continually run large current account deficits to meet the liquidity needs of the world. In the short-run, the reserve currency role benefits from an “exorbitant privilege,” since the issuer country could pay for its imports by printing more currency, whereas non-reserve currency countries could only import by paying in foreign currency.

However, Harry Dexter White rejected the idea of the bancor, because he did not like the idea of the issuance of global currency by a global central bank. Instead, the idea of the Special Drawing Rights was adopted, where the SDR was a reserve unit of account, which could only be created through the exchange of national currencies with the issuer, the International Monetary Fund. As the dominant IMF shareholder, the U.S. could reject the issuance of SDRs, thus ensuring the U.S. dollar remains the dominant reserve currency.

There is common confusion that the SDR can eventually become a reserve currency to replace the dollar. It is a unit of account between the IMF and the member countries, but it cannot be used for international payments. Currently, it is issued to member countries to increase their foreign exchange reserves. However, when the member country needs foreign exchange, it must exchange its SDR holdings with the IMF in four component reserve currencies, namely, the dollar, euro, sterling and yen.

Thus, the components of the SDR can change, but the reserve currency role remains national, not global.

Keynes was right. Sixty-seven years later, the U.S. had become the leading global borrower, whereas the net lenders are Japan, China, Germany and the oil producers, creating what is now called the global imbalance.

Last year, the Italian central banker, Tomaso Padio-Schioppa, gave a speech about the international monetary system, called the “ghost of bancor,” because the idea of bancor was killed in Bretton Woods 67 years ago. Padio-Schioppa, who had a major role in the creation of the euro and became a member of the Board of the European Central Bank, unfortunately died early this year. Interestingly, he equated bancor with Banquo, the Scottish king who was murdered by Macbeth, in the famous Shakespeare play “Macbeth.” As is well known, Macbeth met three witches in the forest who predicted that he would murder his king, Banquo, and become king, but he would be succeeded by Banquo’s successors.

Keynes conceived the idea of bancor as the steward of the king (gold). But the replacement SDR has yet to emerge as an effective replacement for neither gold nor the dollar. At the heart of any global currency (issued by one country, a number of countries or the IMF) remains the Triffin dilemma: what is the hard budget constraint to prevent the global currency issuers from printing too much money and therefore creating global inflation?

The ghost of bancor basically says that no national central bank or a global central bank can resist the temptation of printing too much money.

Currently, the deficit countries blame the surplus countries for saving too much and the surplus countries blame the deficit countries for printing too much money. The reality is that it is the current international monetary system that is flawed. We cannot return to the gold standard, but a fully flexible system of fiat money is also not desirable.

We are in a global collective action trap, where everyone must share a burden of being part of the global game. The difficulty lies in how to allocate that burden in a fair manner.

My humble opinion is that the crisis of fiat money is due to excess consumption financed by excess leverage. That excess consumption is also the fundamental cause of global warming, as natural resources are depleted, while fiat money keeps on increasing. No one likes to use gold, because there would be price deflation which would automatically cut down excess consumption. That is too painful, so everyone still keeps on printing money by passing the pain to savers and future generations.

If there is more and more quantitative easing (money printing) and less and less natural resources in a shrinking world, should we be surprised that gold and oil prices keep on going up?

Who speaks the truth, the ghost of bancor or his successors, the current reserve currency issuers? Perhaps it is the witches in the misty forest, the shadow banking system. 

By Andrew Sheng

Andrew Sheng is the author of “From Asian to Global Financial Crisis.” ― Ed.

(Asia News Network)