Stabilizing the international monetary system

Abstract

The paper focuses on one key difference between the international monetary system of the 1960s and the one prevailing today. In the 1960s, the dollar was the main reserve currency, and governments not wanting to accumulate dollars had only one obvious option—buying gold from the US. Treasury. Today, they have a different option—using dollars to buy euros. There is as yet no firm evidence that Asian central banks are switching from dollars to euros, but a less radical change in their behavior could pose serious problems. They may go on buying dollars to keep their currencies from appreciating but then return to the foreign-exchange market to sell the dollars for euros. The euro would then appreciate sharply, and US interest rates would rise because of the fall in the foreign demand for US government debt. These unwanted effects could be avoided by either of two innovations: (1) The ECB could establish a special facility to accommodate the demand for euros; its liabilities would comprise euro-denominated claims issued off-market to other central banks, and its assets would comprise US government debt. The ECB would incur an exchange-rate risk unless the US Treasury were willing to issue euro-denominated debt in exchange for dollar-denominated debt acquired by the ECB. (2) Central banks could deposit unwanted dollars with a facility administered by the IMF; its liabilities would comprise SDR-denominated claims, and its assets would comprise US government debt indexed to the dollar value of the SDR. The first proposal would confer a large reserve-currency role on the euro. The second would confer that role on the SDR, and it would preclude future instability resulting from subsequent shifts between the dollar and the euro.