## _041310a

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### Gold standard and early IMS evolution
- Gold Standard era: 1870s–1880s; major national currencies freely convertible to gold at fixed exchange rates; adjustment through flexible prices, wages and income.
- Classical Gold Standard survived until the outbreak of the First World War; a modified re-establishment after the war collapsed during the Great Depression in the 1930s.
- Key tensions and dynamics:
  - Adequacy of gold supply problematic—reliance on new discoveries and mining technology.
  - Surplus countries often hoarded gold, undermining the specie flow mechanism.
  - Greater downward wage and price flexibility in that era helped cushion supply constraints.
- Breakdown in the 1930s reflected economic nationalism and political pressure to prioritize domestic objectives over gold convertibility.
- Transition to Bretton Woods: fixed and adjustable exchange rates tied to the U.S. dollar, with the dollar fixed to gold and the IMF overseeing the system; early 1970s saw the dollar’s link to gold broken and most major currencies began to float.
- Reserve asset in floating regime: U.S. Treasury Bills became the major reserve asset; the U.S. dollar remained the key reserve currency.
- Influences shaping the IMS:
  - Geopolitical shifts in dominant powers (U.K. during Gold Standard; U.S. during Bretton Woods).
  - Economic constraints from evolving relative positions of currency issuers and rising cross-border capital flows.
  - Intellectual currents: Keynesian critiques of the Gold Standard; later neoclassical critiques of fixed rates, capital controls, and interventionist policies.
- Strains under Bretton Woods and Triffin dilemma:
  - U.S. deficits needed to supply global reserves while maintaining dollar–gold convertibility created sustainability tensions.
  - Bayoumi and Eichengreen (1995): AD curves steeper and AS curves flatter over time in key open economies, implying increasing absorption of shocks through prices rather than output and growing nominal inertia of domestic prices and wages.
- Sterling–Dollar transition:
  - Sterling’s decline began with the First World War; post–Second World War managed decline by U.K. authorities with bilateral and multilateral support cited as a cooperative transition model.
- Capital flows across regimes:
  - Gold flows theoretically equilibrated via specie flows; practical hoarding by surplus countries worsened interwar turbulence.
  - Crisis-era responses: temporary suspensions of convertibility, lender-of-last-resort actions, cross-central-bank gold loans (example: sterling in the 1890 Baring’s crisis).
  - Post-1930s: protectionism and wartime restrictions led to overwhelmingly official capital flows in the immediate post-war period.
  - Bretton Woods: explicit capital controls allowed pegged exchange rates with monetary autonomy; later microeconomic costs and sophisticated financial markets made comprehensive controls harder to maintain.
  - Private capital flows have grown to dwarf current and official transactions in advanced and many emerging economies.

### II. Reserves growth: a technical analysis
- Definition:
  - IMF Balance of Payments Manual: reserve assets are external assets readily available to and controlled by monetary authorities for balance of payments financing needs, exchange market intervention, and related purposes.
- Extrapolation exercise—assumptions and methodology:
  - Sample: countries accounting for 90 percent of global reserves at market exchange rates in 2008 (39 countries).
  - Convergence assumption: the log of GDP per capita is assumed to converge on U.S. levels at a rate of five percent per year (implying half of the difference is eliminated in about 14 years).
  - Caveat: empirical regional convergence is between 2 and 3 percent and cross-country evidence is contested.
  - Reserves growth model:
    - Starting from each country’s average growth in reserves for 1999-2008, reserves growth is a linear function of relative GDP per capita.
    - All countries at or reaching 70 percent of U.S. GDP per capita are assumed to have secure access to foreign financing and henceforth accumulate at the rate of 5.5 percent—the WEO forecast for global nominal GDP growth 2010-14—or less (if this was the case from 1999-2008).
    - Oil economies: reserves growth converges to global nominal GDP growth by 2015, assuming oil prices and saving-investment balances reach steady state by then.
    - U.S. GDP assumed to grow at the nominal rate of 1999-2008 (5.2 percent), with per capita growth adjusted for UN population forecasts.
    - The exact equation derives from a Cobb-Douglas production function (Barro and Sala-i-Martín, 1995).
- Results and projections:
  - Under the exercise’s assumptions:
    - Global reserves growth falls steadily to 8.5 percent per year by 2035 (from an average of 15.4 percent in 1999-2008).
    - As a proportion of U.S. GDP, reserves are still rising at the end of the period, reaching 690 percent.
  - Data sources: IFS, WEO, UN "World Population Prospects: the 2008 Revision", staff calculations.
- Current accounts and reserve accumulation—empirical observations:
  - Time-series correlation (EMEs 1990–2009):
    - Aggregate change in EME reserves from 1990-2009 is matched virtually one-for-one by the aggregate current account balance.
    - Relationship holds even excluding outliers (notably China), though it weakens.
    - Regression results cited:
      - y = 1.0859x + 96.221, R² = 0.8313 (all EMEs)
      - y = 0.969x + 93.499, R² = 0.5878 (excluding China)
      - y = 0.2697x + 2.2816, R² = 0.1418 (EMEs excluding China and oil exporters)
  - Cross-country (panel) correlation since the late 1990s:
    - Before the Asian crisis, little correlation between reserve accumulation and current accounts; after 1998, a one-for-one relationship becomes evident.
    - Relationship weakens but remains positive if China and oil exporters are excluded.
  - Regional patterns:
    - East Asian countries tended to run current account surpluses and accumulate reserves; some swung from pre-crisis deficits to surpluses (Indonesia, Korea, Malaysia, Thailand).
    - In other regions, accumulation appears to stem from financial investments by non-residents.

### III. Potential reserve currency candidates
- National-currency contenders—overview:
  - Overcoming the U.S. dollar’s ascendancy is difficult due to the unmatched size of the U.S. economy and the depth of its financial markets.
  - Status quo likely preserved in the foreseeable future, though alternatives face challenges that are not necessarily insurmountable.
- Euro:
  - Since 1999, the euro has advanced to be a key global reserve currency, second to the dollar, accounting for more than a quarter of total international reserves.
  - Use largely concentrated in non-euro area EU member states expecting to join the monetary union.
  - Market fragmentation: euro area government securities markets are fairly large but fragmented due to heterogeneity in government credit risks and limited active secondary markets for shorter-term securities.
  - Crisis-era fiscal and balance of payments problems in some euro area countries have raised concerns about the euro.
  - Authorities’ view: the euro was perceived as necessary for the European single market rather than specifically to compete with the dollar; the ECB maintains a neutral stance regarding international use.
- Yen:
  - Since the mid-1990s, Japan has sought to improve financial market infrastructure and remove taxes on foreign investors.
  - Constraints to broader international use:
    - Protracted economic slowdown
    - Low long-term growth potential
    - High public debt burden and low yield
    - Limited room for macro policy
  - Authorities’ view: internationalization of the yen is not an objective in itself; deepening financial markets is part of growth strategy and could boost the yen’s international role.
- Renminbi (RMB):
  - Structural changes required for RMB to become a viable reserve currency: full convertibility and financial sector reform.
  - Current Chinese policies: conservative fiscal and monetary stance with a pegged exchange rate, administered interest rates, directed credit, partial convertibility, and capital controls—supporting low inflation and resilience to external shocks.
  - Constraints on RMB internationalization:
    - Pegged exchange rate reduces attractiveness of RMB assets for diversification and discourages foreign exchange market development.
    - Liberalization of capital controls and financial markets could challenge macroeconomic stability.
  - Authorities’ view: promoting greater international use of the RMB aims to minimize exchange rate risks from the U.S. dollar and address dollar funding shortages for China’s importers; full-fledged reserve currency status is a distant goal.
- Asian and regional currency options:
  - Innovative use of EM currencies as quasi-reserve assets could reduce pressure on traditional reserve suppliers.
  - China has increased regional RMB use in invoicing and settlement and established bilateral currency swap agreements with a total value of recent arrangements at $95 billion.
  - Steps toward offshore RMB market development include issuance of $879 million in RMB-denominated sovereign bonds in Hong Kong.
  - Common Asian currency prospects are distant due to diverse economic and political backgrounds, but rising intra-regional trade and China’s growth could foster regional currency areas or a common Asian currency unit (e.g., proposals leveraging the Chiang Mai Initiative and weighted currency units of China, Japan, Korea).
- Supplement Box III.1 — Desirable features of international reserve currencies:
  - Core characteristics:
    - Deep and liquid financial and foreign exchange markets: prerequisites include currency convertibility, credible commitment to open capital account, liquid financial assets with narrow bid-offer spreads, full yield curve, range of credit qualities.
    - Wide private sector use: large share in world GDP, trade, and finance generates network effects and economies of scale in currency use.
    - Macroeconomic and political stability: credible policymaking institutions with a track record of maintaining price stability.
  - Observations:
    - U.S. financial markets are the most deep and liquid and remained resilient during the recent crisis; some euro area government debt faced severe illiquidity.
    - Going forward, renminbi could emerge as a viable alternative as China’s global share rises, but income per capita and other structural gaps versus existing reserve currency countries remain.
  - Historical shares (1998-07 averages):
    - China: 4.6 percent of global GDP and 5.1 percent of global trade flows.
    - United States: 28.5 percent of global GDP and 13 percent of global trade flows.
    - Japan: 11.2 percent of global GDP and 4.8 percent of global trade flows.

### SDRs—official and private usage, allocations, and policy options
- Official usage:
  - SDR’s global monetary role limited: only SDR 21.4 billion were allocated until mid 2009.
  - Use restricted to the official sector (IMF members, the IMF, and a few prescribed holders), often in members’ operations and transactions with the IMF.
  - Limited usage reflects generally stable store of value of the constituent currencies in recent decades and the SDR’s origin as a solution to dollar liquidity problems under Bretton Woods I.
  - Role in crises: SDRs increased reserve buffers and facilitated reallocation of global liquidity in times of stress, demonstrated by the SDR 183 billion allocations in mid-2009 and subsequent transactions among members.
- Private usage:
  - Private-sector use of SDR-denominated instruments has been very limited.
  - Historical levels:
    - First private SDRs appeared in 1975.
    - By 1981, SDR-denominated bank deposits (excluding interbank deposits) were estimated at SDR 5-7 billion.
    - SDR-denominated bond or note issuances totaled SDR 563 million by 1981.
    - Syndicated loans amounted to SDR 1.2 billion in 1981-82.
  - Contributing constraints: strength of underlying currencies (particularly the U.S. dollar), absence of robust market making and clearing and payments settlement mechanisms.
  - Infrastructure development (clearing, settlement, market making) essential for private use to take hold (see Houguet and Tadesse, 2009).
- SDR allocations and liquidity:
  - Allocation rules:
    - Require a “long-term global need” to supplement reserve assets, consistent with the Fund’s purposes and avoiding economic stagnation/deflation and excess demand/inflation.
    - Allocation and cancellation decisions must be adopted by the Board of Governors with an 85 percent majority of the votes of SDR Department participants (currently, all IMF members).
    - Allocations are made for specified consecutive periods—by default annually within 5-year periods, unless specified otherwise.
    - SDRs are allocated to members in proportion to quota, and their use is unconditional.
  - Size and policy considerations:
    - International reserves increased annually on average by about $600 billion over 2000-09.
    - Up to two-thirds of that increase are estimated by some measures to have been for precautionary purposes.
    - Following the crisis, reserve accumulation may increase further.
    - To limit reserve accumulation policies that strain the system and increase the stock (and role) of SDRs, large and regular allocations may be needed—perhaps on the order of $200 billion or more annually for some years.
    - Allocations consistent with meeting the “long-term global need” need not always be consistent with avoiding adding to inflation expectations.
    - Allocations that are not spent would not impact money supply; allocations that are spent could impact money supply depending on sterilization by central banks.
- Analytic safeguards and options:
  - Option 1: View governance safeguards as adequate and amend the Articles to eliminate current analytic requirements.
  - Option 2: Opt for modest allocations (example: $25 billion annually or up to 10 percent of quota as suggested by Clark and Polak, 2004) which would slow significantly the move to an SDR-based system.
  - Option 3: Add conditions on use (would require amendment to the Articles), though this would conflict with SDR’s unconditional use and reduce attractiveness versus other reserves.
- Targeting and escrow mechanisms:
  - Alternative: target smaller, periodic allocations to a subset of members accumulating reserves for precautionary purposes; calibrating amounts to quota offers simplicity, uniformity, transparency, but variations in financial openness and development complicate matching needs.
  - Escrow option: regular allocations held in escrow (e.g., with the SDR Department) for use in the event of an observable, exogenous, and temporary shock (would require an amendment to the Articles); countries availing escrowed amounts would be required, after a defined period, to reconstitute the SDRs back to the escrow account.
  - Conditional use: increase role of SDRs in financing IMF lending instruments, which could increase SDRs in circulation depending on means of repayment of Fund credit (whether in SDRs or members’ currency).
- IMF operational role:
  - The Fund acts as a broker among members or between members and prescribed holders to facilitate exchanges of SDRs for freely usable currencies via voluntary trading arrangements.
  - The GRA can hold SDRs and sell them to members needing SDRs for meeting financial obligations to the Fund.
  - The Fund is not currently permitted to buy SDRs from a member against currencies of other members; this could be changed by adopting policies on currencies that would be provided in exchange (Article V, section 6c).
  - Changing this would enable the Fund to play a larger role in the official SDR market, but implications of greater GRA acquisition of SDRs on adequacy of Fund resources for lending would need assessment.
- Broadening prescribed holders and private issuance:
  - The IMF could consider broadening the number of prescribed holders.
  - Far-reaching reform: allowing the private sector to hold official SDRs (e.g., commercial banks), although as prescribed holders they would not participate in allocations and would be disallowed from holding net short positions in the SDR to minimize counter-party risk.
  - Sovereign issuance of SDR-denominated bonds would generate a yield curve and create critical mass of SDR-denominated instruments, which could spur private sector issuance.
  - Settlement systems and clearing would be needed; with some modifications, existing major clearing and settlement systems could handle SDR-denominated securities.
- Unit of account:
  - The Fund could promote use of the SDR as a unit of account in official publications of international statistics in a concerted move to an SDR-based system.

### V. A global currency: institutional considerations
- Institutional underpinnings:
  - Setting up a bancor-based system requires resolving technical and governance challenges related to creating a global central bank with clear policy objectives and instruments, and a financial and governance structure ensuring credibility and legitimacy.
  - Political hurdles are significant and apply to all systemic reform solutions.
- Global central bank—key design features:
  - Bank must earn a very strong reputation and credibility.
  - Appropriate rules and governance are essential; the bank should have a strong balance sheet.
  - Members would need to pledge to back up liabilities of the bank and annually cover any losses incurred in its operations.
  - Credibility could be bolstered by capital subscriptions from member countries at a level that ensures the highest possible credit rating (“AAA”).
  - Member subscriptions could be similar to IMF quotas and determined by a transparent formula reflecting relative weight in the global economy.
  - Profits (and seigniorage) could be distributed to members according to capital subscriptions.
- Policy objective:
  - Issuance of bancor (or implementation of monetary policy) could target stabilizing the price of a representative basket of goods and services (and perhaps assets).
  - An international standard basket could be defined, with weights based on respective GDPs of countries.
  - Stable value of bancor would be defined in terms of this international basket.
- Instruments and operations:
  - The central bank would conduct market operations, buying and selling bancor-denominated securities issued by member governments in exchange for bancor issuances and bancor-denominated deposits at the central bank.
  - Operations could be distributed across markets, perhaps in proportion to countries’ economic and financial weights.
  - Amounts of operations by market determined by overall objectives and fine-tuned with experience, balancing liquidity provision (including in stress) and maintaining bancor’s store of value.
- Governance:
  - Governing body composed of representatives of national governments or central banks, with voting shares reflecting shares of their economies in global GDP, trade, and finance, and domestic usage of bancors.
  - Shares adjusted periodically for differential growth; representatives should have strong monetary policy credentials.
  - Governance structure designed to protect operational decisions from political influence and maintain credibility; accountability structures to membership would need to be put in place.
- Transition to a bancor-based system:
  - A fiat declaring sole use of bancor in member countries, particularly systemically important ones, would launch the bancor-based system once technical and governance matters are resolved.
  - In absence of such fiat, sustained public sector support for enhancing bancor’s use would be necessary, akin to proposals outlined for the SDR system, until a critical mass of bancor and bancor-denominated securities is achieved.
  - Alternatively, a transition from an SDR-based system could be envisaged, with eventual conversion of SDRs to bancor.

*Prepared by A. Piris (SPR) et al.; excerpted chapter content from the supplied IMF PDF source.*

### 1.      Gold standard. The modern history of the IMS starts with the shift from a bimetallic

### Gold standard. The modern history of the IMS starts with the shift from a bimetallic

### Gold standard and early IMS evolution
- Under the Gold Standard (1870s–1880s), major national currencies were freely convertible to gold at a fixed exchange rate; adjustment occurred largely through flexible prices, wages and income.
- The classical Gold Standard survived until the outbreak of the First World War; a modified re-establishment after the war was followed by collapse during the Great Depression in the 1930s.
- Key tensions:
  - Adequacy of gold supply to support trade and activity increases was problematic due to reliance on new discoveries and mining technology.
  - Surplus countries often hoarded gold, undermining the specie flow mechanism.
  - Greater downward wage and price flexibility in that era helped cushion supply constraints.
- Breakdown in the 1930s reflected economic nationalism and political pressure to prioritize domestic objectives over gold convertibility.

### From fixed to floating exchange rates
- Post-war Bretton Woods system: fixed and adjustable exchange rates tied to the U.S. dollar, with the dollar fixed to gold and the IMF overseeing the system.
- Repeated strains culminated in the early 1970s when the dollar’s link to gold was broken and most major currencies began to float.
- The U.S. dollar remained the key reserve currency; U.S. Treasury Bills were the major reserve asset in the floating regime.

### Influences shaping the IMS
- Geopolitical: the rise and decline of dominant powers (U.K. during Gold Standard; U.S. during Bretton Woods) influenced system stability.
- Economic: evolving relative economic positions of currency issuers and the rise of cross-border capital flows constrained feasible policy options (exchange rate pegs, capital controls).
- Intellectual: Keynesian reaction against Gold Standard and later neoclassical critiques of fixed rates, capital controls, and interventionist policies influenced system design.

### Strains and ruptures: domestic priorities and the Triffin dilemma
- Under Bretton Woods, reserve asset supply issues re-emerged as the “Triffin dilemma”: the U.S. needed to run deficits to supply global reserves and maintain dollar convertibility into gold—creating sustainability tensions.
- The rise of Europe and Japan with higher growth made fixed exchange rates harder to maintain.
- Bayoumi and Eichengreen (1995) evidence: aggregate demand (AD) curves became steeper and aggregate supply (AS) curves flatter over time in key open economies, implying:
  - Economic shocks were increasingly absorbed through prices rather than output (policymakers more concerned with domestic employment).
  - Growing nominal inertia of domestic prices and wages reduced credibility of commitments to exchange parities.

### The Sterling–Dollar transition
- Sterling’s decline began with the First World War; post–Second World War managed decline by U.K. authorities with bilateral and multilateral support is cited as a cooperative transition model.

### Capital flows under different regimes
- Gold flows theoretically equilibrated via specie flows, but practical hoarding by surplus countries (e.g., France and the U.S. accumulating gold lost by the U.K.) worsened interwar turbulence.
- Crisis-era responses included temporary suspensions of convertibility, lender-of-last-resort actions, and cross-central-bank gold loans (e.g., sterling in the 1890 Baring’s crisis).
- Post-1930s protectionism and wartime restrictions led to overwhelmingly official capital flows in the immediate post-war period.
- Under Bretton Woods, explicit capital controls allowed pegged exchange rates with monetary autonomy; microeconomic costs and sophisticated financial markets later made comprehensive controls harder to maintain.
- Private capital flows have since grown to dwarf current and official transactions in advanced and many emerging economies.

---

### II. RESERVES GROWTH: A TECHNICAL ANALYSIS

### Definition of international reserves
- IMF Balance of Payments Manual: reserve assets are external assets readily available to and controlled by monetary authorities for balance of payments financing needs, exchange market intervention, and related purposes.

### Extrapolation exercise: assumptions and methodology
- Sample: countries accounting for 90 percent of global reserves at market exchange rates in 2008 (39 countries).
- Convergence assumption: the log of GDP per capita is assumed to converge on U.S. levels at a rate of five percent per year (implying half of the difference is eliminated in about 14 years).
  - Note: authors flag that this rate may be optimistic; empirical regional convergence is between 2 and 3 percent and cross-country evidence is contested.
- Reserves growth model:
  - Starting from each country’s average growth in reserves for 1999-2008, reserves growth is a linear function of relative GDP per capita.
  - All countries at or reaching 70 percent of U.S. GDP per capita are assumed to have secure access to foreign financing and henceforth accumulate at the rate of 5.5 percent—the WEO forecast for global nominal GDP growth 2010-14—or less (if this was the case from 1999-2008).
  - Oil economies: reserves growth converges to global nominal GDP growth by 2015, assuming oil prices and saving-investment balances reach steady state by then.
  - U.S. GDP assumed to grow at the nominal rate of 1999-2008 (5.2 percent), with per capita growth adjusted for UN population forecasts.
- The exact equation derives from a Cobb-Douglas production function (Barro and Sala-i-Martín, 1995).

### Results and projections
- Under the exercise’s assumptions:
  - Global reserves growth falls steadily to 8.5 percent per year by 2035 (from an average of 15.4 percent in 1999-2008).
  - As a proportion of U.S. GDP, reserves are still rising at the end of the period, reaching 690 percent.
- Data sources noted: IFS, WEO, UN "World Population Prospects: the 2008 Revision", staff calculations.

### Current accounts and reserve accumulation: empirical observations
- Time-series correlation (EMEs 1990–2009):
  - Aggregate change in EME reserves from 1990-2009 is matched virtually one-for-one by the aggregate current account balance.
  - The aggregate relationship holds even excluding outliers (notably China), though it weakens.
  - Regression results (figures in source):
    - y = 1.0859x + 96.221, R² = 0.8313 (all EMEs)
    - y = 0.969x + 93.499, R² = 0.5878 (excluding China)
    - y = 0.2697x + 2.2816, R² = 0.1418 (EMEs excluding China and oil exporters)
- Cross-country (panel) correlation since the late 1990s:
  - Before the Asian crisis, little correlation between reserve accumulation and current accounts; after 1998, a one-for-one relationship becomes evident.
  - Relationship weakens but remains positive if China and oil exporters are excluded.
- Regional patterns:
  - East Asian countries tended to run current account surpluses and accumulate reserves (some swung from pre-crisis deficits to surpluses: Indonesia, Korea, Malaysia, Thailand), possibly leveraging high domestic savings rates.
  - In other regions, accumulation appears to stem from financial investments by non-residents.

---

### III. POTENTIAL RESERVE CURRENCY CANDIDATES

### National-currency contenders: overview
- Overcoming the U.S. dollar’s ascendancy is difficult due to the unmatched size of the U.S. economy and the depth of its financial markets.
- Status quo likely preserved in the foreseeable future, though alternatives face challenges that are not necessarily insurmountable.

### Euro
- Since 1999, the euro has advanced to be a key global reserve currency, second to the dollar, accounting for more than a quarter of total international reserves.
- Use is largely concentrated in non-euro area EU member states expecting to join the monetary union.
- Market fragmentation: euro area government securities markets are fairly large but fragmented due to heterogeneity in government credit risks and limited active secondary markets for shorter-term securities.
- Crisis-era fiscal and balance of payments problems in some euro area countries have raised concerns about the euro.
- Authorities’ view: the euro was perceived as necessary for the European single market rather than specifically to compete with the dollar; the ECB maintains a neutral stance regarding international use.

### Yen
- Since the mid-1990s, Japan has sought to improve financial market infrastructure and remove taxes on foreign investors.
- Constraints to broader international use:
  - Protracted economic slowdown
  - Low long-term growth potential
  - High public debt burden and low yield
  - Limited room for macro policy
- Authorities’ view: internationalization of the yen is not an objective in itself; deepening financial markets is part of growth strategy and could boost the yen’s international role.

### Renminbi (RMB)
- Structural changes required for RMB to become a viable reserve currency: full convertibility and financial sector reform.
- Current Chinese policies: conservative fiscal and monetary stance with a pegged exchange rate, administered interest rates, directed credit, partial convertibility, and capital controls—supporting low inflation and resilience to external shocks.
- Constraints on RMB internationalization:
  - Pegged exchange rate reduces attractiveness of RMB assets for diversification and discourages foreign exchange market development.
  - Liberalization of capital controls and financial markets could challenge macroeconomic stability.
- Authorities’ view: promoting greater international use of the RMB aims to minimize exchange rate risks from the U.S. dollar and address dollar funding shortages for China’s importers; full-fledged reserve currency status is a distant goal.

### Asian and regional currency options
- Innovative use of emerging-market (EM) currencies as quasi-reserve assets could reduce pressure on traditional reserve suppliers.
  - China has increased regional RMB use in invoicing and settlement and established bilateral currency swap agreements with a total value of recent arrangements at $95 billion.
  - Steps toward offshore RMB market development include issuance of $879 million in RMB-denominated sovereign bonds in Hong Kong.
- Common Asian currency prospects are distant due to diverse economic and political backgrounds, but rising intra-regional trade and China’s growth could foster regional currency areas or a common Asian currency unit (e.g., proposals leveraging the Chiang Mai Initiative and weighted currency units of China, Japan, Korea).

### Supplement Box III.1 — Desirable features of international reserve currencies
- Core characteristics:
  - Deep and liquid financial and foreign exchange markets: prerequisites include currency convertibility, credible commitment to open capital account, liquid financial assets with narrow bid-offer spreads, full yield curve, range of credit qualities.
  - Wide private sector use: large share in world GDP, trade, and finance generates network effects and economies of scale in currency use.
  - Macroeconomic and political stability: credible policymaking institutions with a track record of maintaining price stability.
- Observations:
  - U.S. financial markets are the most deep and liquid and remained resilient during the recent crisis; some euro area government debt faced severe illiquidity.
  - Going forward, renminbi could emerge as a viable alternative as China’s global share rises, but income per capita and other structural gaps versus existing reserve currency countries remain.
- China’s historical shares (1998-07 averages):
  - China: 4.6 percent of global GDP and 5.1 percent of global trade flows.
  - United States: 28.5 percent of global GDP and 13 percent of global trade flows.
  - Japan: 11.2 percent of global GDP and 4.8 percent of global trade flows.

---

*Prepared by A. Piris (SPR) et al.; excerpted chapter content from the supplied IMF PDF source.*

### 1.      Official usage. The SDR’s global monetary role has thus far been limited—only

### _041310a - 1.      Official usage. The SDR’s global monetary role has thus far been limited—only

### Official usage
- The SDR’s global monetary role has been limited: only SDR 21.4 billion were allocated until mid 2009.
- Use restricted to the official sector (IMF members, the IMF, and a few prescribed holders), often in members’ operations and transactions with the IMF.
- Limited usage reflects:
  - Generally stable store of value of the constituent currencies in recent decades.
  - Instrument originally designed to solve dollar liquidity problems of the Bretton Woods I era (fixed exchange rates, limited convertibility, closed capital accounts).
  - Subsequent move to flexible exchange rates, suspension of convertibility to gold, and opening of capital accounts removed applicability of the Triffin Dilemma.
- Role in crises:
  - SDRs increased reserve buffers and facilitated reallocation of global liquidity in times of stress, demonstrated by the SDR 183 billion allocations in mid-2009 and subsequent transactions among members.

### Private usage
- Private-sector use of SDR-denominated instruments has been very limited.
- Characteristics:
  - Instruments would follow the SDR basket value but have market-determined interest rates (different from official SDR).
- History and reasons for decline:
  - Private markets in SDR-denominated instruments appeared in the late 1970s and early 1980s, but have virtually disappeared.
  - Contributing factors include strength of underlying currencies (particularly the U.S. dollar) and absence of robust market making and clearance and payments settlement mechanisms.
  - The first private SDRs appeared in 1975. By 1981, SDR-denominated bank deposits (excluding interbank deposits) were estimated at SDR 5-7 billion, and SDR-denominated bond or note issuances totaled SDR 563 million. The narrowing of the SDR currency basket from 16 to 5 currencies and the increase of the SDR interest rate to 100 percent of the underlying market rates in 1981 briefly spurred expansion: syndicated loans amounted to SDR 1.2 billion in 1981-82.
- Infrastructure development (clearing, settlement, market making) is essential for private use to take hold (see Houguet and Tadesse, 2009).

### SDR Allocations and Liquidity
- Allocation rules:
  - Allocations require a “long-term global need” to supplement reserve assets, consistent with the Fund’s purposes and avoiding economic stagnation/deflation and excess demand/inflation.
  - Governance safeguards: allocation and cancellation decisions must be adopted by the Board of Governors with an 85 percent majority of the votes of SDR Department participants (currently, all IMF members).
  - Allocations are made for specified consecutive periods—by default annually within 5-year periods, unless specified otherwise; case for further allocations or cancellations must be reviewed periodically.
  - SDRs are allocated to members in proportion to quota, and their use is unconditional.

- Size (key statistics and considerations):
  - International reserves increased annually on average by about $600 billion over 2000-09.
  - Up to two-thirds of that increase are estimated by some measures to have been for precautionary purposes.
  - Following the crisis, reserve accumulation may increase further.
  - To limit reserve accumulation policies that strain the system and increase the stock (and role) of SDRs, large and regular allocations may be needed—perhaps on the order of $200 billion or more annually for some years.
  - Allocations consistent with meeting the “long-term global need” need not always be consistent with avoiding adding to inflation expectations (e.g., during periods of heightened inflation risk).
  - Allocations that are not spent would not impact money supply; allocations that are spent could impact money supply depending on sterilization by central banks.

- Analytic safeguards (options):
  - Option 1: View governance safeguards as adequate and amend the Articles to eliminate current analytic requirements.
  - Option 2: Opt for modest allocations (example: $25 billion annually or up to 10 percent of quota as suggested by Clark and Polak, 2004) which would slow significantly the move to an SDR-based system.
  - Option 3: Add conditions on use (would require amendment to the Articles), though this would conflict with SDR’s unconditional use and reduce attractiveness versus other reserves.

- Targeting:
  - Alternative: target smaller, periodic allocations to a subset of members accumulating reserves for precautionary purposes.
  - Calibrating amounts to quota offers simplicity, uniformity, transparency, but variations in financial openness and development complicate matching needs to allocation amounts.
  - Such targeting would require an amendment to the Articles and should be accompanied by a quid pro quo.

- Escrow and reconstitution:
  - Option to have regular allocations held in escrow (e.g., with the SDR Department) for use in the event of an observable, exogenous, and temporary shock (would require an amendment to the Articles).
  - Countries availing escrowed amounts would be required, after a defined period, to reconstitute the SDRs back to the escrow account.
  - Escrowed SDRs could mimic desirable features of reserves—available when needed and relatively costless compared with “borrowed” reserves.

- Conditional use:
  - Complementary approach: increase role of SDRs in financing IMF lending instruments, which could increase SDRs in circulation depending on means of repayment of Fund credit (whether in SDRs or members’ currency).

- IMF as broker:
  - The Fund acts as a broker among members or between members and prescribed holders to facilitate exchanges of SDRs for freely usable currencies via voluntary trading arrangements.
  - The GRA can hold SDRs and sell them to members needing SDRs for meeting financial obligations to the Fund (e.g., for payment of SDR Department or GRA charges).
  - The Fund is not currently permitted to buy SDRs from a member against currencies of other members; this could be changed by adopting policies on currencies that would be provided in exchange (Article V, section 6c).
  - Changing this would enable the Fund to play a larger role in the official SDR market, but implications of greater GRA acquisition of SDRs on adequacy of Fund resources for lending would need assessment.

### SDR Usage
- Broadening prescribed holders:
  - The IMF could consider broadening the number of prescribed holders.
  - Far-reaching reform: allowing the private sector to hold official SDRs (e.g., commercial banks), although as prescribed holders they would not participate in allocations and would be disallowed from holding net short positions in the SDR to minimize counter-party risk.
  - Private uptake could promote broader acceptance of the SDR as a reserve asset and enable central banks to use SDRs for direct market intervention.

- Private issuance:
  - Sovereign issuance of SDR-denominated bonds would generate a yield curve and create critical mass of SDR-denominated instruments, which could spur private sector issuance.
  - Large financial institutions and multinational companies could issue such bonds to diversify funding sources and foreign exchange exposure.

- Settlement:
  - A clearing and settlement system would be needed for SDR-denominated securities issuance and transactions.
  - With some modifications, existing major clearing and settlement systems could handle SDR-denominated securities.

- Unit of account:
  - In a concerted move to an SDR-based system, the Fund could promote use of the SDR as a unit of account in official publications of international statistics.
  - Currently, the SDR is used as a unit of account among only a handful of international organizations; broader use could follow increases in market invoicing in SDRs.

### V. A GLOBAL CURRENCY: INSTITUTIONAL CONSIDERATIONS — Institutional underpinnings
- Setting up a bancor-based system requires resolving technical and governance challenges related to creating a global central bank with clear policy objectives and instruments, and a financial and governance structure ensuring credibility and legitimacy.
- Political hurdles are significant and apply to all systemic reform solutions.

- Global central bank (key design features):
  - Bank must earn a very strong reputation and credibility.
  - Appropriate rules and governance are essential; the bank should have a strong balance sheet.
  - Members would need to pledge to back up liabilities of the bank and annually cover any losses incurred in its operations.
  - Credibility could be bolstered by capital subscriptions from member countries at a level that ensures the highest possible credit rating (“AAA”).
  - Member subscriptions could be similar to IMF quotas and determined by a transparent formula reflecting relative weight in the global economy.
  - Profits (and seigniorage) could be distributed to members according to capital subscriptions.

- Policy objective:
  - Issuance of bancor (or implementation of monetary policy) could target stabilizing the price of a representative basket of goods and services (and perhaps assets).
  - An international standard basket could be defined, with weights based on respective GDPs of countries.
  - Stable value of bancor would be defined in terms of this international basket.

- Instruments:
  - The central bank would conduct market operations, buying and selling bancor-denominated securities issued by member governments in exchange for bancor issuances and bancor-denominated deposits at the central bank.
  - Operations could be distributed across markets, perhaps in proportion to countries’ economic and financial weights.
  - Amounts of operations by market determined by overall objectives and fine-tuned with experience, balancing liquidity provision (including in stress) and maintaining bancor’s store of value.

- Governance:
  - Governing body composed of representatives of national governments or central banks, with voting shares reflecting shares of their economies in global GDP, trade, and finance, and domestic usage of bancors.
  - Shares adjusted periodically for differential growth.
  - Representatives should have strong monetary policy credentials.
  - Governance structure designed to protect operational decisions from political influence and maintain credibility.
  - Accountability structures to membership would need to be put in place.

- Transition to bancor-based system:
  - A fiat declaring sole use of bancor in member countries, particularly systemically important ones, would launch the bancor-based system once technical and governance matters are resolved.
  - In absence of such fiat, sustained public sector support for enhancing bancor’s use would be necessary, akin to proposals outlined for the SDR system, until a critical mass of bancor and bancor-denominated securities is achieved.
  - Alternatively, a transition from an SDR-based system could be envisaged, with eventual conversion of SDRs to bancor.

*Prepared by R. Goyal and P. Khandelwal (SPR), with inputs from FIN, LEG, and MCM.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2010/_041310a.pdf_