Mr. Zhou Xiaochuan, Chairman of Monetary Policy Committee of the People's Bank of China (PBoC), has created quite some buzz with his proposal to Reform the International Monetary System. I expressed my surprise earlier here, and clearly I misunderstood it at first. After rereading his proposal carefully, I don’t think it is very much constructive.
Now Mr. Zhou is widely recognized as an achieved monetarist, with an extended knowledge and unparallel insights of international and domestic economic and monetary matters - I have admittedly learned a great deal studying his influential speeches.
On this specific issue, however, I would have to express a somewhat different opinion.
The Proposal
I don’t need to repeat the well known and escalating global imbalance – tons of literatures are available online. Mr. Zhou’s proposal is to expand the role of IMF’s Special Drawing Rights (SDRs) as the international reserve for transaction clearance among nations, replacing the prevailing USD. A full page of SDR description here.
To summarize it, IMF allocate SDRs to nations on a specific quota. The initial quota is here (it reads like a will, with the U.S. being the favorite son) and the change of it requires “[a]n eighty-five percent majority of the total voting power.” The value and interest rate is equivalent to that a basket of major currencies - today consisting of the euro, Japanese yen, pound sterling, and U.S. dollar.
Why SDR Won’t Solve the Problem
SDR is a type of money. Though not the money that you can do shopping with, nevertheless it is money. The function of money is: a medium of exchange, a unit of account, and a store of value. Mr. Zhou’s worry comes from USD’s store of value, or inflation.
Is SDR inflation-proof? Think of it as a basket of currencies – expand to include all world currencies if you like – the shares proportional to trade volume (not that important actually), so that you can create synthetic SDR with that basket of currencies.
The value of SDR, or your basket of currencies, is measured by what you can buy on them. (Yes, value of goods are measured by money as well as the value of money is measured by goods. So wicked!) When some country for some reason prints a lot of money, it inflates and its currency depreciates. If the currency is in the basket, the purchase power of your basket depreciates as well.
If China exchanges a basket of USD for SDR, inflation remains a concern – except instead of distrusting the United States you have to distrust many countries’ monetary policies. I would argue that the United States appears a bit more reliable on this one – it takes much pressure (though increasingly possible) to inflate in the United States, a nation of whiners, on almost everything.
What To Do Then?
I honestly have no idea – told you that money is much a headache. It appears there is nowhere to run, except that China could manage RMB effectively, only without a large amount of foreign reserves as a byproduct of the export-driven growth strategy.
There are however several ideas to explore. One is the TIPS, though the Chinese reserve is oversized for it. Another one is holding assets correlated to inflations, and it introduces new source of risks. The U.S. treasury is risk free – check your corporate finance textbook if you have any doubt. Or should we maybe reconsider the Gold Standard? Historically it has been a source of problems.
Alas! Nowhere to run. Why is money necessary?
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