The writer is IMF chief economist
The global discussion on the future of money has been irreversibly altered in the six months since Facebook announced plans for a digital currency. While Libra’s own prospects have dimmed, major central banks are considering whether “public” digital currencies are needed to fill a gap in retail payment needs.
Some analysts suggest that the addition of private and central bank-backed digital currencies could provide the long expected but elusive shock that finally dislodges the US dollar from its decades-long dominance in global trade and finance. These technological advances could also become the ingredients for a “synthetic hegemonic currency” — a digital basket of reserve currencies — as recently proposed by outgoing Bank of England governor Mark Carney.
While these are intriguing possibilities, they are improbable in the near term. Improvements in payment technology may have lowered the cost of switching from cash to digital payments, but there is little evidence they have done much to reduce the expense of moving among currencies. Such costs are non-pecuniary. Widely-held perceptions of the dollar’s safety and stability have kept it dominant in the international monetary system for decades.
The dollar holds strongly reinforcing roles in trade invoicing — it accounts for five times the US share of world trade — and global banking. These have created large network effects: the more people use the dollar, the more useful it becomes to everyone else. This has been reinforced as emerging markets, which rely extensively on the dollar, increase their share of global economic activity. Their share of global domestic product now stands at 60 per cent.
Advances in payment technologies do not address fundamental issues of what it takes to be a global reserve currency. Consider the euro, which has been the leading contender to replace the dollar over the past 20 years. Its impact on the dollar’s dominance has been modest at best, owing to financial fragmentation, inadequate fiscal risk-sharing, and slow progress on the euro area’s governance framework. Uncertainty about the long-term stability of the eurozone does not help. It is difficult to imagine how technology would address these issues.
The dollar’s status is bolstered by the institutions, rule of law, and credible investor protection that the US is seen as providing. Simply raising the supply of an alternative currency will not be enough to surmount these considerations. Chinese efforts to internationalise the renminbi have met only limited success despite a policy push and liquidity support through bilateral swaps with more than 30 central banks.
When sovereign governments, investors, and traders are confronted with digital currency choices, they are likely to reassess what currency to use for transactions across borders. Their choice will be based on many of the same factors as in the past — liquidity, stability, convertibility — but also new concerns, such as the technological superiority of the issuing country. This latter issue could become a decisive factor, given legitimate concerns about privacy and security with digitised monies.
Few sovereigns will meet such criteria. The US may parlay its leadership in combating global money laundering and terrorism finance into making the dollar the dominant digital currency.
Despite high hopes, it is difficult to see how technology can hasten the creation of a “synthetic hegemonic currency”. Trade and financial contracts continue to be denominated overwhelmingly in a single currency, rather than a basket of currencies. For such a public synthetic alternative to work, central banks, whose currencies underlay it, would have to co-ordinate to ensure its stability and reduce perceived risks. But global needs can conflict with monetary policy objectives at home, significantly reducing the attraction for leading reserve currencies to participate.
Digital currencies issued by big tech firms would undoubtedly have some advantages relative to fiat currencies. Large-scale offerings such as China’s WeChat Pay offer seamless integration of multiple services on a single platform, combined with a low-cost and user-friendly payment system. Even so, the likelihood that one would give rise to a distinct unit of account disconnected from a fiat currency is remote, not least due to the complex regulatory and jurisdictional issues involved.
The international monetary system needs work. We need cheaper and faster cross-border payments: currently, settlement of cross-border remittances is slow, costly, and burdensome to those least able to afford it. Technology can bring quick gains here and improve financial inclusion. Recognising its potential and risks, the G20 has asked the IMF to look at the macroeconomic implications of global stablecoins.
The world would also benefit from a more balanced system in which the euro and the renminbi have a bigger role. But technology cannot solve this problem alone. It takes old-fashioned development of institutions to improve the euro area’s architecture and resilience, and stronger domestic institutions and further liberalisation of markets in China.
This piece expresses the author’s personal views