When Beijing Studied John Maynard Keynes

The Special Drawing Rights* were created in 1969 in the context of the Bretton Woods system of exchange values in response to a concern about the lack of liquidity in the international financial system.

The initial aim was for it to be used as a reserve currency, although nowadays it is used in the IMF’s trade with member states. Beijing has proposed the replacement of the U.S. dollar as the reserve currency with a new global currency controlled by the IMF.

The new global reserve currency could be derived from a basket of powerful currencies as the evolved form of the IMF’s Special Drawing Rights. Moscow endorses the same. Bejing’s plan can win the support of the emerging markets that have enormous reserve assets. Presumably, however, that plan may have an unrealistic aspect. The total amount of the SDR now equals $32 billion. That is less than 2 percent of China’s reserve assets. On the other hand, the U.S. national debt tops $16 trillion.

However, there are two major obstacles. The U.S. objects to Beijing’s plans because, if the dollar loses its sovereignty, then financing its enormous deficits would become more difficult. However, Bejiing will have to reconsider its plan. Beijing has adopted the proposal that John Maynard Keynes made in 1940 about creating an international currency based on goods. However, Keynes had in mind imposing taxes on the countries that might have enormous deficits in current transactions, aiming at encouraging domestic demand.

Beijing and also Moscow’s argument is based on the ‘”Triffin dilemma,” according to which U.S. external deficits are inevitable as long as the U.S. dollar is the only global reserve currency in the world. In a famous warning to Congress in 1960, the Belgian Yale economist Robert Triffin explained that as the marginal supplier of the world’s reserve currency, the U.S. had no choice but to run persistent current account deficits. As the global economy expanded, demand for reserve currencies increased. These could only be supplied to foreigners by the U.S. running a current account deficit and issuing dollar-denominated obligations to fund it.

If the U.S. stopped running a balance of payments deficits and supplying reserves, the resulting “shortage of liquidity could pull the global economy into a contractionary spiral.” That is exactly what Triffin said in 1961. We should note that demand for foreign exchange reserves forces developing countries to transfer resources to the countries issuing those reserve currencies.

However, the dollar’s weakness — against other key currencies — will not by itself inflict valuation losses on the the People’s Bank of China since there would be no change in the Yuan value on the dollar component of China’s reserves. Beijing still pegs the Yuan to the dollar, ignoring Washington’s long-term efforts to break China’s unfairly manipulated exchange rate between the two currencies.

*Editor’s note: According to the IMF website, the SDR or Special Drawing Rights is “an international reserve asset, created by the IMF in 1969 to supplement its member countries’ official reserves.”