11

Currency WarsCurrency WarsAPPENDICESAPPENDICES

Jeffrey FrankelJeffrey FrankelHarpel Professor of Capital Formation & Growth,Harpel Professor of Capital Formation & Growth,

Harvard University Harvard University

MAS Sponsored Public Lecture, Singapore, March 2011MAS Sponsored Public Lecture, Singapore, March 2011

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Appendices: The big 3 currenciesAppendices: The big 3 currencies

Appendix I: The end of $ hegemony?

Appendix II: Is RMB appreciation in China’s own interest?

Appendix III: Predictions – Sovereign debt troubles & the €

Appendix IV: More on the trend to a multiple reserve system

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Appendix 1: Appendix 1: The end of dollar hegemony ?The end of dollar hegemony ?

Some argue the US current account Some argue the US current account deficit is sustainable indefinitely.deficit is sustainable indefinitely.• They believe that the US will continue to enjoy They believe that the US will continue to enjoy

its unique “exorbitant privilege,” its unique “exorbitant privilege,” able to borrow unlimited amounts in its own currencyable to borrow unlimited amounts in its own currency because it is the dominant international reserve asset.because it is the dominant international reserve asset.

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““Bretton Woods II”Bretton Woods II”

Dooley, Folkerts-Landau, & Garber Dooley, Folkerts-Landau, & Garber (2003) (2003) ::

• today’s system is a new Bretton Woods,today’s system is a new Bretton Woods, with Asia playing the role that Europe played with Asia playing the role that Europe played

in the 1960s—buying up $ to prevent in the 1960s—buying up $ to prevent their own currencies from appreciating.their own currencies from appreciating.

• More provocatively: More provocatively: China is piling up dollars China is piling up dollars not because of myopic mercantilism, not because of myopic mercantilism, but as part of an export-led development strategy but as part of an export-led development strategy that is rational given China’s need to import workable that is rational given China’s need to import workable systems of finance & corporate governance.systems of finance & corporate governance.

55

My own view on Bretton Woods II:My own view on Bretton Woods II:

• The 1960s analogy is indeed apt, The 1960s analogy is indeed apt, • but we are closer to 1971 than to 1944 or 1958. but we are closer to 1971 than to 1944 or 1958.

• Why did the BW system collapse in 1971?Why did the BW system collapse in 1971?

The Triffin dilemma could have taken decades The Triffin dilemma could have taken decades to work itself out.to work itself out.

But the Johnson & Nixon But the Johnson & Nixon administrations accelerated administrations accelerated the processthe process by fiscal & monetary expansion by fiscal & monetary expansion (driven by the Vietnam War & Arthur Burns, respectively).(driven by the Vietnam War & Arthur Burns, respectively).

These policies produced: declining external balances, These policies produced: declining external balances, $ devaluation, & the end of Bretton Woods$ devaluation, & the end of Bretton Woods. .

66

There is no reason to expect better today:There is no reason to expect better today:

1)1) Capital mobilityCapital mobilityis much higher now than in the 1960s.is much higher now than in the 1960s.

2)2) The US can no longer rely The US can no longer rely on support of foreign central banks:on support of foreign central banks:

neither on economic groundsneither on economic grounds

(they are not now, as they were then, (they are not now, as they were then, organized into a cooperative framework where organized into a cooperative framework where each agrees explicitly to hold $ if the others do), each agrees explicitly to hold $ if the others do),

nor on political groundsnor on political grounds

(these creditors are not the staunch allies (these creditors are not the staunch allies the US had in the 1960s). the US had in the 1960s).

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The financial crisis caused a flight to quality The financial crisis caused a flight to quality which evidently still means a flight to US $.which evidently still means a flight to US $.

US Treasury bills in 2008-09 were more in demand US Treasury bills in 2008-09 were more in demand than ever, as reflected in very low interest rates.than ever, as reflected in very low interest rates.

The $ The $ appreciatedappreciated, rather than depreciating as the “hard landing” , rather than depreciating as the “hard landing” scenario had predicted.scenario had predicted.

=> The day of reckoning had not yet arrived.=> The day of reckoning had not yet arrived.

Chinese warnings Chinese warnings (2009)(2009) may have been a turning point: may have been a turning point:• Premier Wen worried US T bills will lose value.Premier Wen worried US T bills will lose value.

• PBoC Gov. Zhou proposed PBoC Gov. Zhou proposed replacing $ as international replacing $ as international currency, with SDR.currency, with SDR.

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Multiple international Multiple international reserve asset systemreserve asset system

The € now exists as a rival to the $.The € now exists as a rival to the $.

The ¥ & SF are also safe havens.The ¥ & SF are also safe havens.

The SDR came back The SDR came back from the dead in 2009.from the dead in 2009.

Gold made a comeback as Gold made a comeback as an international reserve too.an international reserve too.

Someday the RMB will join the rosterSomeday the RMB will join the rosterthough it is just beginning now.though it is just beginning now.

= a multiple international reserve currency system.= a multiple international reserve currency system.

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Countries should have the right to fix Countries should have the right to fix their exchange rate if they want to.their exchange rate if they want to.

True, the IMF Articles of Agreement True, the IMF Articles of Agreement and the US Omnibus Trade Act of 1988 and the US Omnibus Trade Act of 1988 call for action in the event that a country call for action in the event that a country is “unfairly manipulating its currency”.is “unfairly manipulating its currency”.

ButBut• Few countries have been forced to appreciate.Few countries have been forced to appreciate.• Pressure on surplus countries to appreciate will inevitablyPressure on surplus countries to appreciate will inevitablybe less than pressure on deficit countries to depreciate.be less than pressure on deficit countries to depreciate.• I support ending the language of “manipulation.”I support ending the language of “manipulation.”

Usually, it is hard to say when a currency is undervalued.Usually, it is hard to say when a currency is undervalued. Don’t cheapen the language that is appropriate to WTO rules.Don’t cheapen the language that is appropriate to WTO rules.

China should do what is in its own long-term interest.China should do what is in its own long-term interest.

Appendix II: What is in China’s interest?Appendix II: What is in China’s interest?

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Five reasons why China should let Five reasons why China should let the RMB appreciate, in its own interestthe RMB appreciate, in its own interest

1.1. Overheating of economyOverheating of economy

2.2. Reserves are excessive. Reserves are excessive. • It gets harder to sterilize the inflow over time.It gets harder to sterilize the inflow over time.

3.3. Attaining internal and external balance.Attaining internal and external balance.• To attain both, need 2 policy instruments. To attain both, need 2 policy instruments. • In a large country like China, In a large country like China,

expenditure-switching policy should be the exchange rate.expenditure-switching policy should be the exchange rate.

4.4. Avoiding future crashes.Avoiding future crashes.

5.5. RMB undervalued, judged by RMB undervalued, judged by Balassa-Samuelson relationship.Balassa-Samuelson relationship.

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1. Overheating of economy:1. Overheating of economy: Bottlenecks. Pace of economic growth is outrunning:Bottlenecks. Pace of economic growth is outrunning:

• raw material supplies, andraw material supplies, and• labor supply in coastal provinceslabor supply in coastal provinces• Also:Also:

• physical infrastructurephysical infrastructure• environmental capacityenvironmental capacity• level of sophistication of financial system.level of sophistication of financial system.

Asset bubbles.Asset bubbles.• Shanghai stock market bubble in 2007.Shanghai stock market bubble in 2007.

Inflation 6-7% in 2007 Inflation 6-7% in 2007 => price controls=> price controls shortages & social unrest.shortages & social unrest.

All of the above was suspended in late 2008,All of the above was suspended in late 2008,• due to global recession.due to global recession.• But it is back again now; skyrocketing real estate prices.But it is back again now; skyrocketing real estate prices.

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Attempts at “sterilization,” to insulate Attempts at “sterilization,” to insulate domestic economy from the inflowsdomestic economy from the inflows

Sterilization is defined as offsettingSterilization is defined as offsettingof international reserve inflows,of international reserve inflows,so as to prevent them from showing upso as to prevent them from showing updomestically as excessive money growth & inflation.domestically as excessive money growth & inflation.

For awhile PBoC successfully sterilized…For awhile PBoC successfully sterilized…• until 2007-08.until 2007-08.

• The usual limitations finally showed up:The usual limitations finally showed up: Prolongation of capital inflowsProlongation of capital inflows <= self-equilibrating mechanism shut off. <= self-equilibrating mechanism shut off. Quasi-fiscal deficit:Quasi-fiscal deficit: gap between domestic interest rates & US T bill rate gap between domestic interest rates & US T bill rate Failure to sterilize:Failure to sterilize: money supply rising faster than income money supply rising faster than income Rising inflationRising inflation (admittedly due not only to rising money supply) (admittedly due not only to rising money supply) Rising asset pricesRising asset prices

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After the interruption of mid-2008 to mid-2009After the interruption of mid-2008 to mid-2009 ((<= big one-year loss of China’s exports due to global recession),<= big one-year loss of China’s exports due to global recession),

overheating resumed: rapid rise of land pricesoverheating resumed: rapid rise of land prices

Real Beijing land prices

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2. Foreign Exchange Reserves2. Foreign Exchange Reserves

Excessive:Excessive:• Though a useful shield against currency crises, Though a useful shield against currency crises, • China has enough reserves: $2 ½ China has enough reserves: $2 ½ trilliontrillion by by April 2010;April 2010;

• & US treasury securities do not pay high returns.& US treasury securities do not pay high returns.

Harder to sterilize Harder to sterilize the inflow over time.the inflow over time.

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Source: HKMA, Half-Yearly Monetary and Financial Stability Report, June 2008

The Balance of Payments≡ rate of change of foreign exchange reserves (largely $),

rose rapidly in China over past decade,due to all 3 components:

trade balance, Foreign Direct Investment, and portfolio inflows

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While reserves (NFA) rose rapidly, the growth of the monetary basewas kept to the growth of the real economy – even reduced in 2005-06.

Successful sterilization in China: 2005-06Attempts to sterilize reserve inflow:Attempts to sterilize reserve inflow:

were remarkably successful in 2005-06.were remarkably successful in 2005-06.

High reserve growth

offset by cuts indomestic credit

=> steady money

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In 2007-08 China began to have more In 2007-08 China began to have more trouble sterilizing the reserve inflowtrouble sterilizing the reserve inflow

PBoC began to pay higher interest rate PBoC began to pay higher interest rate domestically, & receive lower domestically, & receive lower interest rate on US T bills interest rate on US T bills => quasi-fiscal deficit.=> quasi-fiscal deficit.

Inflation became a serious problem.Inflation became a serious problem.• True, global increases in food & energy pricesTrue, global increases in food & energy prices

were much of the explanation.were much of the explanation.• ButBut

China’s overly rapid growth itself contributed.China’s overly rapid growth itself contributed. Appreciation is a good way to put immediate downward Appreciation is a good way to put immediate downward

pressure on local prices of farm & energy commodities.pressure on local prices of farm & energy commodities. Price controls are inefficient and ultimately ineffective.Price controls are inefficient and ultimately ineffective.

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Sterilization faltered in 2007 & 2008Sterilization faltered in 2007 & 2008

Source: HKMA, Half-Yearly Monetary and Financial Stability Report, June 2008

Monetary baseaccelerated

Growth of China’smonetary base,

& its components

1919

New York Times Jan 12, 2011

Foreign exchange reserves held by

the People’s Bank

of China are approaching

$3 trillion in 2011.

2020

New York Times Jan 12, 2011

The Chinese money supply has almost doubled in the last

3 years, contributing to a rapid growth

aggregate demandas reflected in nominal GDP.

No wonder inflation is rising again.

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3. Need a flexible exchange rate to 3. Need a flexible exchange rate to attain internal & externalattain internal & external balancebalance

Internal balance ≡ Internal balance ≡ demand neither too low (recession) nor too high demand neither too low (recession) nor too high (overheating).(overheating).

External balance ≡ appropriate balance of payments.External balance ≡ appropriate balance of payments.

General principle: to attain both policy targets, General principle: to attain both policy targets, a country needs to use 2 policy instruments.a country needs to use 2 policy instruments.

For a country as large as China, one of those policy For a country as large as China, one of those policy instruments should be the exchange rate.instruments should be the exchange rate.

To reduce BoP surplus without causing higher unemployment, To reduce BoP surplus without causing higher unemployment, China needs bothChina needs both• currency appreciation, currency appreciation, and and • expansion of domestic demandexpansion of domestic demand

gradually replacing foreign demand,gradually replacing foreign demand, developing neglected sectors: developing neglected sectors:

health, education, environment, housing, finance, & services.health, education, environment, housing, finance, & services.

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4. Avoiding future crashes4. Avoiding future crashes

Experience of other emerging markets Experience of other emerging markets suggests it is better to exit from a peg in suggests it is better to exit from a peg in good times, when the BoP is strong, than good times, when the BoP is strong, than to wait until the currency is under attack.to wait until the currency is under attack.

Introducing some flexibility now, even though not ready for free floating.

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5. Longer-run perspective:5. Longer-run perspective:Balassa-Samuelson relationshipBalassa-Samuelson relationship

Prices of goods & services in China are lowPrices of goods & services in China are low• compared at the nominal exchange rate.compared at the nominal exchange rate.• Of course they are a fraction of those in the U.S.: < ¼ .Of course they are a fraction of those in the U.S.: < ¼ .• This is to be expected, This is to be expected,

explained by the Balassa-Samuelson effectexplained by the Balassa-Samuelson effect which says that low-income countries have lower price levels.which says that low-income countries have lower price levels. As countries’ real income grows, their currencies experience real As countries’ real income grows, their currencies experience real

appreciation: approx. .3% for every 1 % in income per capita.appreciation: approx. .3% for every 1 % in income per capita.

• But China is one of those countries that is cheap or But China is one of those countries that is cheap or undervalued even taking into account Balassa-Samuelson.undervalued even taking into account Balassa-Samuelson.

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-1-.

50

.51

Lo

g o

f P

rice L

evel

-3 -2 -1 0 1 2Log of Real Per capita GDP (PPP)

coef = .23367193, (robust) se = .01978263, t = 11.81

Source: Arvind Subramanian, April 2010, “New PPP-Based Estimates of Renminbi Undervaluationand Policy Implications,” PB10-08, Peterson Institute for International Economics

Undervaluation of RMB in the regression estimated above = 26%.Estimated undervaluation averaging across four such estimates = 31%.

Compare to Frankel (2005) estimate for 2000 = 36%.

The Balassa-Samuelson Relationship2005

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Appendix III: Debt PredictionsAppendix III: Debt Predictions

Greece will needGreece will needto re-structure its debt.to re-structure its debt.

The euro will survive.The euro will survive.• There is no legal provision There is no legal provision

for members to leave the euro zone.for members to leave the euro zone.

Prices of government bonds in Prices of government bonds in advanced countries in general will fall.advanced countries in general will fall.

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The euro project is lookingThe euro project is lookingfar less successful than just a few years agofar less successful than just a few years ago

Many predictions of euro skeptics have come true:Many predictions of euro skeptics have come true:• Periphery countries and core countries have had trouble Periphery countries and core countries have had trouble

reconciling asymmetric monetary needs.reconciling asymmetric monetary needs.• Euro members have not had enough labor mobility Euro members have not had enough labor mobility

or flexibility to make up for it.or flexibility to make up for it.

• Efforts to prevent excessive debt & bailouts have failed:Efforts to prevent excessive debt & bailouts have failed: The Stability & Growth Pact failed The Stability & Growth Pact failed with members big & small.with members big & small. The “No bailout clause” has failed with Greece.The “No bailout clause” has failed with Greece.

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Frankfurt & Brussels Frankfurt & Brussels made 4 mistakes regarding Greecemade 4 mistakes regarding Greece

2001: They let Greece into the euro2001: They let Greece into the euro

2002-09: ECB accepted Greek debt as collateral2002-09: ECB accepted Greek debt as collateral• despite consistent violation of SGP.despite consistent violation of SGP.• => Did not allow interest rate spreads to open up.=> Did not allow interest rate spreads to open up.

Winter 2010: Did not tell Greece to go to the IMF. Winter 2010: Did not tell Greece to go to the IMF. Preferred instead to “handle it internally.”Preferred instead to “handle it internally.”

Still today: No “Plan B” to restructure Greek debt Still today: No “Plan B” to restructure Greek debt (and save the bailout fund for more deserving banks & PIIGs).(and save the bailout fund for more deserving banks & PIIGs).

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Judging from spreads, 2001-07, Judging from spreads, 2001-07, investors put zero odds on a default by Greece investors put zero odds on a default by Greece

or other Mediterranean countriesor other Mediterranean countries

Council on Foreign Relations

2929

Suddenly, in 2010, the Greek sovereign spread Suddenly, in 2010, the Greek sovereign spread shot up, exceeding 800% by June. shot up, exceeding 800% by June.

Even when the Greek crisis erupted, Even when the Greek crisis erupted, leaders in Brussels & Frankfurt leaders in Brussels & Frankfurt seemed to view it as a black swan, seemed to view it as a black swan, • instead of recognizing it as a close cousin instead of recognizing it as a close cousin

of the Argentine crisis of ten years earlier, of the Argentine crisis of ten years earlier, and many others in history,and many others in history,

• including among European countries.including among European countries.

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Sovereign debt worriesSovereign debt worries ......

• The next big asset market to fall• after the stock market in 2000• the housing market in 2006• and banking in 2008

• will likely be sovereign debt• among the advanced economies.

• The major emerging market countries are in much better shape,

• in an amazing & historic role reversal.

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Sovereign spreads for 5 euro countries shot up in the 1st half of 2010

Creditworthiness: Some advanced economics Creditworthiness: Some advanced economics have fallen, as emerging markets have risen.have fallen, as emerging markets have risen.

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A remarkable role-reversal:

• Debt/GDP of the top 20 rich countries (≈ 80%) is already twice that of the top 20 emerging markets;

• and rising rapidly.

• By 2014 (at ≈ 120%), it could be triple.

3333

Even judged by ratings of credit Even judged by ratings of credit agencies, emerging markets are now agencies, emerging markets are now intermingled with advanced countriesintermingled with advanced countries

• Singapore’s credit rating is now above Belgium’sSingapore’s credit rating is now above Belgium’s• China’s rating rose above Japan’s in JanuaryChina’s rating rose above Japan’s in January• Taiwan is above Italy Taiwan is above Italy • Chile is above Israel Chile is above Israel • Korea is above Portugal Korea is above Portugal • Malaysia is above IrelandMalaysia is above Ireland• South Africa is above IcelandSouth Africa is above Iceland• India is above Greece. India is above Greece.

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Ratings for “Emerging Economies”Ratings for “Advanced Economies”

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When does the “privilege” become “exorbitant?”When does the “privilege” become “exorbitant?”

if it accrues solely because of size and history, without if it accrues solely because of size and history, without the US having done anything to earn the US having done anything to earn the benefit by virtuous policies such as budget the benefit by virtuous policies such as budget discipline, price stability & a stable exchange rate. discipline, price stability & a stable exchange rate.

Since 1973, the US has racked up $10 trillion Since 1973, the US has racked up $10 trillion in debt and the $ has experienced a 30% loss in debt and the $ has experienced a 30% loss in value compared to other major currencies.in value compared to other major currencies.

It seems unlikely that macroeconomic policy discipline It seems unlikely that macroeconomic policy discipline is what has earned the US its privilege !is what has earned the US its privilege !

Appendix IV: More on the trend from $ hegemony to a multiple reserve system

3636

Some argue that the privilege to incur $ Some argue that the privilege to incur $ liabilities has been earned in a different way:liabilities has been earned in a different way:

Global savings glutGlobal savings glut (Bernanke)(Bernanke)

The US appropriately exploits its comparative advantage The US appropriately exploits its comparative advantage in supplying high-quality assets to the rest of the worldin supplying high-quality assets to the rest of the world ..

• ““Intermediation rents…pay for the trade deficits.” Intermediation rents…pay for the trade deficits.” -- Caballero, Farhi & Gourinchas-- Caballero, Farhi & Gourinchas (2008)(2008)

• In one version, the US has been operating as the World’s In one version, the US has been operating as the World’s Venture Capitalist, accepting short-term liquid deposits and Venture Capitalist, accepting short-term liquid deposits and making long-term or risky investmentsmaking long-term or risky investments -- Gourinchas & Rey-- Gourinchas & Rey (2008)(2008)..

• US supplies high-quality assets:US supplies high-quality assets:Cooper Cooper (2005);(2005); Forbes Forbes (2008);(2008); Ju & Wei (2008);Ju & Wei (2008); Hausmann & Sturzenegger Hausmann & Sturzenegger (2006a, b);(2006a, b); Mendoza, Quadrini Mendoza, Quadrini & & Rios-RullRios-Rull (2007a, b)…(2007a, b)…

3737

The argument that the US offers assets of superior The argument that the US offers assets of superior quality, and so has earned the right to finance its quality, and so has earned the right to finance its deficits, was undermined by the dysfunctionality deficits, was undermined by the dysfunctionality revealed in the financial crisis of 2007-08. revealed in the financial crisis of 2007-08.

American financial institutions suffered a severe American financial institutions suffered a severe loss of credibility loss of credibility (corporate governance, accounting (corporate governance, accounting standards, rating agencies, derivatives, etc.), standards, rating agencies, derivatives, etc.),

How could sub-prime mortgages be How could sub-prime mortgages be the superior type of assets that uniquely the superior type of assets that uniquely merit the respect of the world’s investors?merit the respect of the world’s investors?

3838

But the events of 2008-09 also But the events of 2008-09 also undermined the opposing interpretation, undermined the opposing interpretation, the unsustainability position: the unsustainability position:

Why no hard landing for the $, as long feared? Why no hard landing for the $, as long feared? The $ appreciated after Lehman Brothers’ The $ appreciated after Lehman Brothers’

bankruptcy, & US T bill interest rates fell. bankruptcy, & US T bill interest rates fell.

Clearly in 2008 the world still viewed Clearly in 2008 the world still viewed • the US Treasury market as a safe haven and the US Treasury market as a safe haven and

• the US $ as the premier international currencythe US $ as the premier international currency..

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Is the $’s unique role Is the $’s unique role an eternal god-given constant? an eternal god-given constant?

Or will a sufficiently long record of deficits & Or will a sufficiently long record of deficits & depreciation induce investors to turn elsewheredepreciation induce investors to turn elsewhere??

Though arguments about the unique high quality of US private assets have been tarnished, the idea of America as World Banker is still alive: the $ is the world’s reserve currency, by virtue of US size & history.

4040

Historical precedent: £Historical precedent: £ ’s loss of premier ’s loss of premier international currency status in 20international currency status in 20thth century century

By 1919, US had passed UKBy 1919, US had passed UK in in

1.1. output (1872)output (1872)

2.2. trade (1914)trade (1914)

3.3. net international creditor position (1914-19)net international creditor position (1914-19)

Subsequently, Subsequently, $ passed £ as #1 reserve currency $ passed £ as #1 reserve currency (1940-45).(1940-45).

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From the literatureFrom the literatureon reserve currencieson reserve currencies

Determinant: Determinant:

1.1. SizeSize

2.2. Depth of Fin.mkt.Depth of Fin.mkt.

3. Rate of return3. Rate of return

Proxy:Proxy:

GDPGDP

FX turnoverFX turnover

inflation,inflation,LR depreciation,LR depreciation,Exch. rate varianceExch. rate variance

4242

From the literature, From the literature, continuedcontinued

Network externalities Network externalities

=> Tipping => Tipping captured by:captured by:

1)1) InertiaInertia lagslags

2)2) NonlinearityNonlinearity logistic functional formlogistic functional form

in determinantsin determinants oror

dummy for leader GDPdummy for leader GDP

4343

0.0

0.2

0.4

0.6

0.8

1.0

75 80 85 90 95 00 05 10 15 20 25 30 35 40

USD

DEM

EUR

Chinn & Frankel Chinn & Frankel (2005)(2005)

Projection of $ vs € Projection of $ vs € as shares of central banks’ foreign exchange reserves: as shares of central banks’ foreign exchange reserves:

a function of country size, financial market depth, & rate of return, a function of country size, financial market depth, & rate of return, with parameters estimated on 1973-98 datawith parameters estimated on 1973-98 data..Simulation assumes $ depreciation continues at 2001-04 rate.Simulation assumes $ depreciation continues at 2001-04 rate.

birthof €€

This scenario showed € This scenario showed € overtaking $ as top international overtaking $ as top international

reserve currency in 2022.reserve currency in 2022.

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International Currency RolesInternational Currency RolesTable B

Adapted from Kenen Function of money:

Governments Private actors

Store of value

International reserve holdings

Currency substitution (private dollarization)

Medium of exchange

Vehicle currency for foreign exchange intervention

Invoicing trade and financial transactions

Unit of account

Anchor for pegging local currency

Denominating trade and financial transactions

More on a multiple-asset international reserve system

4545

A multiple reserve currency system is inefficient, A multiple reserve currency system is inefficient, in the same sense that barter is inefficient: in the same sense that barter is inefficient: money was invented in the first place to cut down money was invented in the first place to cut down on the transactions costs of exchange. on the transactions costs of exchange.

Nevertheless, if sound macro policies Nevertheless, if sound macro policies in the leader country cannot be presumed, in the leader country cannot be presumed, the existence of competitor currencies gives the existence of competitor currencies gives the rest of the world protection against the leader the rest of the world protection against the leader exploiting its position by running up too much exploiting its position by running up too much debt and then inflating/depreciating it away.debt and then inflating/depreciating it away.

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GoldGold

Gold was seen as an anachronism Gold was seen as an anachronism just a few years ago:just a few years ago:• the world’s central banks were selling off their stocks.the world’s central banks were selling off their stocks.

Gold re-joined the world monetary system in 2009:Gold re-joined the world monetary system in 2009:• The PBoC, RBI, & other Asian central banks The PBoC, RBI, & other Asian central banks

bought gold, to diversify their reserves.bought gold, to diversify their reserves.• Even in advanced countries, central banks Even in advanced countries, central banks

appear to have stopped selling.appear to have stopped selling.

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Special Drawing RightsSpecial Drawing Rights

The SDR has made a surprising comeback as a potential The SDR has made a surprising comeback as a potential international money, from near-oblivion. international money, from near-oblivion.

The G20 in 2009 decided to create new SDRs ($250b). The G20 in 2009 decided to create new SDRs ($250b). Shortly later, PBoC Gov. Zhou proposed replacing Shortly later, PBoC Gov. Zhou proposed replacing

the $ as lead international currency with the SDR. the $ as lead international currency with the SDR. The IMF is now borrowing in SDRs. The IMF is now borrowing in SDRs. The proposal has been revived for an international The proposal has been revived for an international

substitution account at the IMF, to extinguish an unwanted substitution account at the IMF, to extinguish an unwanted $ overhang in exchange for SDRs. $ overhang in exchange for SDRs.

The SDR has little chance of standing up as a competitor The SDR has little chance of standing up as a competitor to the € or ¥, let alone to the $. to the € or ¥, let alone to the $.

Still, it is back in the world monetary system.Still, it is back in the world monetary system.

4848http://ksghome.harvard.edu/~jfrankel/index.htm