It may be time to revive Keynes’ idea of a global reserve currency

Context: The US has weaponized its financial power to pressurize Russia to withdraw from Ukraine. The result of sanctions is that Russia cannot access around half of its foreign exchange reserves. This has led to discussion that other countries will try to diversify their reserves away from the US dollar.

Why is the US Dollar the global reserve currency?

The US runs on a structural current account deficit. It has been providing dollars to the rest of the world through this trade gap, by sending dollars rather than goods to countries with which it has a trade deficit.

It is also a global buyer of last resort whenever there has been an economic shock.

What are the advantages to the US?

The US does not face the usual balance of payments constraints. It only needs to print its own currency to pay the rest of the world, while other countries have to earn dollars.

Despite this advantage, there is no other country right now which is ready to replace the US by running a structural current account deficit.

What is the idea of ‘global currency’ as floated by Keynes?

It states that a Global Central Bank (International Clearing Union) would issue a Global Currency (Bancor). Countries would use this to make payments to each other. Each country would get an initial allotment of bancor based on its net exports. The global central bank would be the manager of global liquidity. Bancor was supposed to be an international medium for exchange rather than a store of value.

However, this was rejected by the US at the Bretton Woods conference.

Can the Bancor idea be adopted in our times?

Economists have stated that there can be “common digital currency” – issued and regulated by the International Monetary Fund. The Fund can administer it on the basis of transparent digital distributed ledger and an algorithm that would adjust total supply according to trade volume.

What are the challenges associated with a global currency?

1. Currency is not just a function of trade flows: This means that the countries do not hold global reserve currency only to fund their international transactions, but also as a precaution in case of sudden shock.
2. Global currency and Global central bank cannot be pulled out of thin air: As network effect ensures that countries use the US dollar for transactions because other countries also use it. Any attempt to replace the US dollar will also cause geopolitical headwinds.

However, if global reserve currency is regarded as a public good, then Keynes’ idea can be revisited in the age of digital currencies.

Source: This post is created based on the article “It may be time to revive Keynes’ idea of a global reserve currency” published in Livemint on 23^rd March 2022. Mint