The Problem of Coexistence of SDRs and a Reserve Currency: Comment

Abstract

In a previous issue of this journal, John Makin set out to explain the general stability conditions of the present international monetary arrangement, which is characterized by heterogeneous assets such as gold, dollars, and SDRs. 1 These assets are supposed to coexist in order to provide an adequate growth of international reserves to the world community. I have three general comments on Makin's article. First, the Walras Law of the markets is invoked inappropriately. Second, his dynamic analysis suffers from an error of specification because the effects of an excess demand for SDRs on the U.S. money market are not correctly traced. Under a revised formulation, the necessary and sufficient conditions for stability are somewhat different from those stated in the article. Third, the power of the analytical framework advanced by Makin is reduced (a) by not having explicitly treated the U.S. money market and (b) by implicitly assuming equilibrium conditions in the gold market in his dynamic discussion of the model. Let me first deal with the application of the Walras law. Makin postulates excess demands for gold, dollar assets, and SDRs as a function of the U.S. rate of interest r, the rate of interest on SDRs j, and a measure of risk in holding dollar assets given by the ratio of foreign-held dollar assets to the U.S. gold stock W. By appealing to Walras's law of the markets and recognizing that j is fixed institutionally, the system reduces to two excess demand functions (dollars and SDRs) in unknowns W and r. However, a fourth market is already working in the background of Makin's analysis, namely, the U.S. money market. This is because the United States is assumed all along to be a residual buyer and seller of SDRs in pretty much the same way that she was the ultimate buyer and seller of gold before August 15, 1971.2 Since this behavior affects the demand for and supply of U.S. money and, consequently, the rate of