Last week, I attended the second annual meeting of the Institute for New Economic Thinking, at the Mount Washington Hotel, nestled in a beautiful valley in Bretton Woods, New Hampshire. In 1944, the historic meeting on the international monetary system was held there.
The British delegation was led by Lord Keynes, the foremost economic thinker of his day. The American delegation was effectively led by US Treasury adviser Harry Dexter White. Even though all the Allies attended the meeting, including China and India, it was essentially a debate between the declining superpower, Britain, and the rising superpower, the United States.
Keynes understood full well the problem that Britain faced as the issuer of sterling. Since Britain was running large current account deficits because of the two world wars, it was having a tough time maintaining sterling as the main reserve currency. By the end of the second world war, the US emerged as the dominant global power, since it ran large current account surpluses by supplying food and raw materials to Europe in exchange for gold. To avoid the Triffin dilemma, Keynes argued for the creation of a new international currency, called Bancor, that would not be related to the issue of a national reserve currency.
The Triffin dilemma is the problem the issuer of the global reserve currency faces in having to continually run large current account deficits to meet the liquidity needs of the world. In the short term, the issuer country benefits from an 'exorbitant privilege', since it could pay for its imports by printing more currency, whereas other countries could only import by paying in foreign currency.
However, White rejected the idea of the Bancor because he did not like the idea of a global central bank issuing a global currency. Instead, the idea of the special drawing rights (SDRs) was adopted, where the SDR is an international reserve asset created by the International Monetary Fund through the exchange of national currencies. As the dominant IMF shareholder, the US could reject the issuance of SDRs, thus ensuring the US dollar remains the dominant reserve currency.
There is common confusion that the SDR can eventually become a reserve currency to replace the US dollar. It is a unit of account between the IMF and its member countries, but it cannot be used for international payments. Currently, it is issued to member countries to increase their foreign exchange reserves. However, when the member country needs foreign exchange, it must exchange its holdings of SDRs with the IMF in four component reserve currencies, namely, the US dollar, the euro, sterling and the yen.
