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By Root 908 0

and sterling were substitutable because of their simultaneous equivalence to gold. Devaluations did occur, but after each devaluation the anchor was reset. After Bretton Woods, the anchor consisted of the dollar and gold, and since 1971 the anchor has consisted of the dollar as the leading reserve currency. Yet in the postwar world there has always been a reference point. Never before have multiple paper reserve currencies been used with no single anchor. Consequently, the world Eichengreen envisions is a world of reserve currencies adrift. Instead of a single central bank like the Fed abusing its privileges, it will be open season with several central banks invited to do the same at once. In that scenario, there would be no safe harbor reserve currency and markets would be more volatile and unstable.

One disturbing variation on Eichengreen’s optimistic vision consists of regional currency blocs, with local dominance by the dollar, euro and yuan, and possibly the ruble in Russia’s area of influence in Eastern Europe and Central Asia. Such blocs can arise spontaneously according to well-known models of self-organization in complex systems. Regional currency blocs could quickly devolve into regional trading blocs with diminished world trade, undoubtedly the opposite of what the advocates of multiple reserve currencies such as Eichengreen envision.

Eichengreen expects what he calls healthy competition among multiple reserve currencies. He discounts models of unhealthy competition and dysfunction—what economists call a “race to the bottom,” which can arise when leading central banks lock in regional dominance through network effects and simultaneously abuse their reserve status by money printing. The best advice for advocates of the multiple reserve currency model is “Be careful what you wish for.” This is an untested and untried model, absent gold or some single currency anchor. The missing-anchor problem may be one reason why the dollar continues to dominate despite its difficulties.

Special Drawing Rights

Perhaps no feature of the international monetary system is more shrouded in mystery and confusion for the nonexpert than the special drawing right, or SDR. This should not be the case, because the SDR is a straightforward device. The SDR is world money, controlled by the IMF, backed by nothing and printed at will. Once the IMF issues an SDR, it sits comfortably in the reserve accounts of the recipient like any other reserve currency. In international finance, the SDR captures the mood of the 1985 Dire Straits hit “Money for Nothing.”

Experts object to the use of the word “money” in describing special drawing rights. After all, individual citizens can’t obtain them, and if you walk into a liquor store and try paying for a few bottles of wine with SDRs, you will not get very far. However, SDRs do satisfy the traditional definition of money in many respects. SDRs are a store of value because nations maintain part of their reserves in SDR-denominated assets. They are a medium of exchange because nations that run trade deficits or surpluses can settle their local currency trade balances with other nations in SDR-denominated instruments. Finally, SDRs are a unit of account because the IMF keeps its books and records, its assets and liabilities in SDR units. What is different about SDRs is that citizens and corporations in private transactions cannot yet use them. But plans are already afoot inside the IMF to create just such a private market.

Another objection to treating SDRs as money is based on the fact that SDRs are defined as a basket of other currencies, such as dollars and euros. Analysts with this view say that SDRs have no value or purpose independent of the currencies in the basket and so they are not a separate form of money. This is incorrect for two reasons. The first reason is that the amount of issuance of SDRs is not limited by any amount of underlying currencies in the basket. Those underlying currencies are used to calculate value but not to limit quantity—SDRs can be issued in potentially unlimited