A Special Moment for Special Drawing Rights

NEW YORK – The recent annual meetings of the International Monetary Fund and the World Bank in Lima, Peru, were dominated by talk of the weakness of several emerging and developing economies. But the discussion focused very little on one key cause: the global monetary system. Much more will be said next month at the IMF board, though what the Fund will do remains an open question.

The problem that emerging and developing economies are facing stems from the fact that their capital inflows follow a strongly pro-cyclical pattern. When they were growing rapidly – especially compared to the advanced economies – they attracted massive amounts of capital. But as risks multiplied, capital started to flow back toward a reserve-issuing country – namely, the United States. After all, the US is set to raise interest rates, and the dollar has appreciated against virtually all of the world’s currencies.

In the past, this pattern has always ultimately led to a correction, with America’s growing current-account deficit eventually bringing about a dollar depreciation. But such corrections – in 1979-1980, 1990-1991, and 2007-2008 – have also always been associated with a global slowdown or crisis.

This highlights the problem inherent in using the US dollar, a national currency, as the global economy’s primary international-reserve currency. The Belgian economist Robert Triffin first identified this problem – dubbed the “Triffin dilemma” – in the 1960s, emphasizing the fundamental conflict between national objectives, such as limiting the size of the external deficit, and international imperatives, such as creating enough liquidity to satisfy demand for reserve assets. Moreover, this system subjects the world economy to cycles of confidence in the US dollar, while placing the world economy at the mercy of a national authority – one that often makes decisions with scant regard for their international implications.