In a speech at the Jackson Hole symposium at the weekend, Bank of England Governor Mark Carney raised the question of a global digital reserve currency, asking whether it may not be the most suitable long term solution to reform of the international monetary and financial system (IMFS).
In a wide ranging speech on the challenges facing monetary policy in the current system, Carney noted that the switch over to the dollar as the world’s reserve currency from sterling in the early part of the last century caused no little disruption and upset the world order as two competing providers of reserve currencies served to destabilise the international monetary system, and the lack of coordination between them contributed to the global scarcity in liquidity and worsened the severity of the Great Depression.
He then raised the prospect of the same happening as the renmimbi moved centre stage as a potential reserve currency, but noted, that “much more is required” before that can happen, and that, “When it comes to the supply of reserve currencies, coordination problems are larger when there are fewer issuers than when there is either a monopoly or many issuers.”
Carney added that while the rise of the Renminbi may “over time” provide a second best solution to the current problems with the IMFS, first best would be to build a multipolar system.
The main advantage of a multipolar IMFS is diversification, he suggested, adding that multiple reserve currencies would increase the supply of safe assets and alleviate the downward pressures on the global equilibrium interest rate. He also noted that with many countries issuing global safe assets in competition with each other, the safety premium they receive should fall. This framework would also reduce spillovers from the core and by so doing lower the synchronisation of trade and financial cycles, which would in turn reduce the fragilities in the system, and increase the sustainability of capital flows, pushing up the equilibrium interest rate.
“While the likelihood of a multipolar IMFS might seem distant at present, technological developments provide the potential for such a world to emerge,” he continued.” Such a platform would be based on the virtual rather than the physical.”
Carney then went on to argue that history shows that the rise of a reserve currency is founded on its usefulness as a medium of exchange, and that the additional functions of money – as a unit of account and store of wealth – come later, and reinforce the payments motive. “Technology has the potential to disrupt the network externalities that prevent the incumbent global reserve currency from being displaced,” he stated, noting that the most high profile challenger has been Facebook’s Libra.
“There are a host of fundamental issues that Libra must address, ranging from privacy to AML/CFT and operational resilience,” he said. “In addition, depending on its design, it could have substantial implications for both monetary and financial stability. The Bank of England and other regulators have been clear that unlike in social media, for which standards and regulations are only now being developed after the technologies have been adopted by billions of users, the terms of engagement for any new systemic private payments system must be in force well in advance of any launch.”
This led Carney to suggest that a new Synthetic Hegemonic Currency (SHC) may be best provided by the public sector, perhaps through a network of central bank digital currencies. “Even if the initial variants of the idea prove wanting, the concept is intriguing,” he argued. “It is worth considering how an SHC in the IMFS could support better global outcomes, given the scale of the challenges of the current IMFS and the risks in transition to a new hegemonic reserve currency like the renminbi.
“An SHC could dampen the domineering influence of the US dollar on global trade,” he continued. “If the share of trade invoiced in SHC were to rise, shocks in the US would have less potent spillovers through exchange rates, and trade would become less synchronised across countries. By the same token, global trade would become more sensitive to changes in conditions in the countries of the other currencies in the basket backing the SHC.
“The dollar’s influence on global financial conditions could similarly decline if a financial architecture developed around the new SHC and it displaced the dollar’s dominance in credit markets,” Carney added. “By reducing the influence of the US on the global financial cycle, this would help reduce the volatility of capital flows to emerging market economies. Widespread use of the SHC in international trade and finance would imply that the currencies that compose its basket could gradually be seen as reliable reserve assets, encouraging emerging market economiess to diversify their holdings of safe assets away from the dollar. This would lessen the downward pressure on equilibrium interest rates and help alleviate the global liquidity trap.”
Carney concluded by noting that while there would be many execution challenges, not least the risk of fragmentation across digital currency areas, but that by leveraging the medium of exchange role of a reserve currency, an SHC might smooth the transition that the IMFS needs.