The current global financial crisis has unsurprisingly intensified calls to reform the governance of the International Monetary Fund. Richard Cooper’s article, “Necessary Reform: The IMF and International Financial Architecture” (Winter 2008), parallels Chinese Governor Zhou Xiaochuan’s speech on March 23, 2009. In the speech, Zhou suggested broadening IMF governance to better reflect the rising economic importance of emerging markets with an uneasy hold on large reserves of dollar assets; in light of this, he advocated the revival of the IMF’s Special Drawing Rights (SDR) facility. It would act as a “super-sovereign reserve currency” to replace purely national currencies, such as the US dollar, in official exchange reserves. Fortuitously, Cooper analyzed several of the important issues that Zhou raises.
First is the issue of “legitimate” governance. Cooper has been a leading advocate to greatly expand IMF voting and borrowing rights to emerging in order to better reflect their economic reform. This would require a sharp fall in the voting rights of medium-sized European countries (below the current 31 percent), while possibly ending the convention of a European IMF Managing Director. However, Cooper admits that such reform before the global financial crisis would not have made any difference. During this era of the “great moderation,” there were therefore no significant demands for drawings from the IMF.
In my view, the huge US cumulative current-account deficits essentially prevented most emerging markets from international borrowing, so that they could not (as in the past) build up unsustainable foreign currency (dollar) debts that led to devaluations. Because the dollar was effectively international money, the United States alone had an ultra-soft international borrowing constraint, free to increase debt without devaluation risk. It is this asymmetry of international currency arrangements that Zhou wants to change by rehabilitating SDR.
But is this possible? Cooper points out that the SDR is not itself an independent monetary entity, but rather a unit of account based on the purchasing powers of the underlying dollar, euro, pound sterling, and yen. Cooper argues, “To deal with a market crisis, the SDRs would have to be converted into the national currencies relevant for dealing with the financial crisis.” Yet this is feasible only if the government of the country whose national currency is demanded agrees to accept SDRs in exchange. Furthermore, the IMF has no means to independently determine the real purchasing power of SDRs in terms of goods and services. Because private markets do not exist to buy and sell SDRs, the IMF cannot target some putative “world” price level. Therefore, SDRs are viewed as relatively illiquid assets of uncertain purchasing power—unattractive for trade-surplus countries to hold unless the IMF prevailed on them to do so. While they became a rather cheap line of credit to poor countries who spent them immediately, they did not prove effective substitutes for the more liquid dollar assets. The SDR facility atrophied, and the amount of SDRs outstanding today is only US$32 billion.
Zhou identifies real problems with international currency asymmetry: the dollar standard and (I would add) the euro standard in Eastern Europe. But Cooper probably agrees with me that the SDR route that Zhou envisions is not—and has not been—a promising way of dealing with the underlying asymmetries. In the absence of a single super-sovereign world money, globalization through increased trade and capital flows results in a financial system that is inherently fragile.