A Global Central Bank and Currency?

By Ron Robins, Founder & Analyst, Investing for the Soul

Blog Enlightened Economics; twitter

First published January 27, 2011, in his weekly economics and finance column at
alrroya.com

There are many paths forward for the global monetary system, but the hitherto
unthinkable is becoming debatable: a global central bank and currency. However,
despite the recent financial distress and potential for further financial calamity, the
creation of such a new institution or currency is far off. But would a global central
bank with possibly its own currency help bring monetary solace, universal prosperity
and humankind together? Or would such a bank and currency result in yet another
calamitous monetary failure?

The 2008-2009 financial debacle showed just how unprepared the global financial
system was to deal with a loss of faith in, and imploding of, the global banking
system. To stave off a global financial meltdown, the central banks of the US, the
EU, Japan and many others around the world advanced vast sums in loans and
guarantees to banks and financial entities. And the US Federal Reserve (the Fed) in
particular loaned out hundreds of billions of dollars to foreign-owned banks, in effect
acting as a bank of last resort to the global banking system.

As big as the Fed is, it and other central banks, for many reasons, may not be able
to address the demands of a future global financial maelstrom with possibly even
larger calls for loans of last resort. For the Fed, this is due to 1) the declining relative
importance of the US economy and the dollar in relation to the global economy, and
2) potential political interference in its activities.

The mounting problems and lessening importance of the US economy and its dollar
globally are obviously why a new international currency regime is being considered.
International Monetary Fund (IMF) data (published in The Economist magazine)
shows that while the US now makes up about 24 per cent of global gross domestic
product (GDP), its dollar accounts for 84 per cent of foreign exchange transactions.
Furthermore, over 60 per cent of international central bank reserves and about 60
per cent of global bank deposits are denominated in US dollars.

The continuing use of the US dollar internationally is largely dependent on the

performance of the US economy and its domestic fiscal and monetary policies.
Domestically, the US government is growing massive unsustainable debts while the
Fed is hugely expanding the creation of new money and the buying of US
government bonds (its quantitative easing programs). These actions are likely to
further devalue the US dollar globally. Thus, holders of US dollars and assets will
increasingly be less interested in retaining them.

Rising to compete with the US dollar has principally been the euro. However, with its
member countries’ debt problems, the attention is turning primarily to China’s yuan.
It is probably no accident that on January 12 China made a significant step forward
in yuan foreign exchange convertibility by allowing it to trade in the US. China has
also recently made deals with Russia, Brazil and other countries to settle trade
accounts in yuan.
Such gains in the international acceptance of the yuan make it likely to be included
in the revised and re-invigorated Special Drawing Rights (SDR) issued by the IMF.
The SDR is presently a type of currency used in a limited way among central banks
and the IMF. However, its role could eventually be expanded and in the decades
ahead might even form the basis of a global currency.

The SDR comprises a basket of currencies that include the US dollar, yen, euro and
pound sterling. Besides including the yuan, a revised form of SDR might include
additional currencies and even gold or other commodities as well. As gold has an
inherent market value, proponents for its inclusion suggest it could help bring further
stability to the SDR. Changes to the SDR are favoured by many countries such as
Russia and France.

Hence, the IMF may well begin to act in the coming years as a quasi global central
bank. However, Barry Eichengreen of the University of California in the US cautions—
quoting the Economist magazine of November 4, 2010—that, “no global
government… means no global central bank, which means no global currency. Full
stop.” Economists like Mr Eichengreen have the weight of evidence on their side
regarding the need for a global government before a true global central bank and
currency could come about. One only needs to look at the European Central Bank’s
problems to see how the lack of an overarching, integrated and authoritative
governance structure greatly impeded its ability to deal with the recent crises.

Advocating against the concept of a global central bank and currency are some free
market proponents such as Ron Paul, a US Republican and now chairman of the
powerful US Congress’s Monetary Policy Sub-committee. He and many others believe
currencies should be freely chosen and have intrinsic value, backed by commodities,
most likely that of gold. They say without gold backing, any currency and central
bank issuing such currency, is deemed to eventual failure due to the historical fact
that governments inevitably print excessive amounts of money. This ‘printing’
thereby debases the currency’s value and essentially commits fraud against the
holders of the affected currency.

It is possible that the world may proceed towards a global central bank and currency
over time. In the near future, the IMF will probably revise, re-invigorate and expand
its SDR program to assist in the transition from reserve dependence on the US
dollar. But the dangers with the SDR are that it is still largely linked to the viability
and variability of national economies and their domestic policies and currencies.
Advocates of a completely free market approach such as that proposed by US
Congressman Ron Paul might also hold sway. The idea of a global central bank and
currency is still just an idea. But it is an idea arising out of the calamity of our
present day reality. It deserves hot debate.

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