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Trade dollars for an even more imaginary currency -- just please don't spend them!

Section: Daily Dispatches

7:41p ET Monday, December 10, 2007

Dear Friend of GATA and Gold:

What may be a trial balloon was floated today in the Financial Times via an essay by a former U.S. Treasury Department official, Fred Bergsten, headlined "How to Solve the Problem of the Dollar," which is appended here.

Bergsten proposes allowing sovereign holders of huge dollar surpluses to exchange them for Special Drawing Rights in an account at the International Monetary Fund. "The account would invest the dollar deposits in US securities," Bergsten writes. "If additional backing were deemed necessary, the fund's gold holdings of $80 billion would more than suffice."

Why any country that has done work and produced things of actual value for its dollar surpluses would exchange them for an even more imaginary currency is hard to understand -- especially since, as Bergsten writes, the dollar surpluses deposited with the IMF would be invested in "US securities," which is only how so much of those dollar surpluses are being held now, in U.S. government debt instruments that can never be repaid.

But Bergsten's reference to the IMF's gold as potential "additional backing" for the extra Special Drawing Rights is interesting. Does he mean that sovereign dollar surplus holders should be allowed to exchange their dollars for gold in something other than free-market circumstances, so that the central bank suppression of the gold price might continue more easily?

In any case Bergsten seems to be saying that the solution to the dollar problem is not to spend all those extra dollars on anything -- to ensure that those extra dollars flooding the world never can be spent, to take them out of circulation before they are returned to their issuer as payment for anything real. But of course that "solution" is only the problem itself now. If you can't spend dollars except for some other instrument you can't spend either, you're never going to get paid, only cheated.

Couldn't those surplus dollar holders at least be allowed to buy, in addition to pretty new SDRs, a few more collateralized debt obligations?

CHRIS POWELL, Secretary/Treasurer
Gold Anti-Trust Action Committee Inc.

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How to Solve the Problem of the Dollar

By Fred Bergsten
Financial Times, London
Monday, December 10, 2007

The world economy faces an acute policy dilemma that, if mishandled, could bring on the mother of all monetary crises.

Many dollar holders, including central banks and sovereign wealth funds as well as private investors, clearly want to diversify into other currencies. Since foreign dollar holdings total at least $20,000 billion, even a modest realisation of these desires could produce a free fall of the US currency and huge disruptions to markets and the world economy. Fears of such an outcome have risen sharply in both official circles and the markets.

However, none of the countries into whose currencies the diversification would take place want to receive these inflows. The eurozone, the UK, Canada, and Australia among others believe that their exchange rates are already substantially overvalued. But China and most of the other Asian countries continue to intervene heavily to keep their currencies from rising significantly. Hence, further large shifts out of the dollar could indeed push the floating currencies far above their equilibrium levels, generating new imbalances and a possibly severe slowdown in global growth.

There is only one solution to this dilemma that would satisfy all parties: creation of a substitution account at the International Monetary Fund through which unwanted dollars could be converted into special drawing rights, the international money created initially by the fund in 1969 and of which $34 billion-worth now exists. Such an account was worked out in great detail in 1978-1980 during an earlier bout of currency diversification and freefall of the dollar that closely resembled today's circumstances.

There was widespread agreement, including from influential private-sector groups and congressional leaders as well as the IMF's governing body, that the initiative would enhance global monetary stability. It failed only because the sharp rise in the dollar that followed the Federal Reserve's monetary tightening of 1979-1980 obviated much of its rationale, and over disagreement between Europe and the US on how to make up for any nominal losses that the account might suffer as a result of further depreciation of dollars that had been consolidated.

The idea of a substitution account is simple. Instead of converting dollars into other currencies through the market, depressing the former and strengthening the latter, official holders could deposit their unwanted holdings in a special account at the IMF. They would be credited with a like amount of SDR (or SDR-denominated certificates), which they could use to finance future balance-of-payment deficits and other legitimate needs, redeem at the account itself, or transfer to other participants. Hence the asset would be fully liquid.

The fund's members would authorise it to meet the demand by issuing as many new SDRs as needed, which would have no net impact on the global money supply (and hence on world growth or inflation) because the operation would substitute one asset for another. The account would invest the dollar deposits in US securities. If additional backing were deemed necessary, the fund's gold holdings of $80 billion would more than suffice.

All countries would benefit. Those with dollars that they deem excessive would receive an asset denominated in a basket of currencies (44 per cent dollars, 34 per cent euros, 11 per cent each yen and sterling), achieving in a single stroke the diversification they seek along with market-based yields. They would avoid depressing the dollar excessively, minimising the loss on their remaining dollar holdings as well as avoiding systemic disruption.

The US would be spared the risk of higher inflation and potentially much higher interest rates that would stem from an even sharper decline of the dollar. Such consequences would be especially unwelcome today with the prospect of subdued US growth or even recession over the next year or so.

The international financial architecture would be greatly strengthened by a substitution account. In the wake of the dollar crises of the early postwar period, the IMF membership adopted SDR as the centrepiece of a strategy to build an international monetary system that would no longer rely on a single currency.

The move to floating exchange rates by most major countries in the 1970s postponed the need to pursue that strategy to its conclusion but also generated the extreme currency instability that triggered official consideration of an account. The global imbalances and large currency swings in recent years, and the accelerated accumulation of official dollar holdings by countries that have essentially reverted to fixed exchange rates, replicate the conditions that led to both the creation of SDR and the negotiations on an account.

A substitution account would not solve all international monetary problems nor would it suffice to restore a stable global financial system.

The dollar needs to decline further to restore equilibrium in the US external position. China, many other Asian countries, and most oil exporters will have to accept substantial increases in their currencies now and much more flexible exchange rates for the long run. But early adoption of a substitution account would minimise the risks of adjustment of the present imbalances and the inevitable structural shift to a bipolar monetary system based on the euro as well as the dollar.


The writer is director of the Peterson Institute for International Economics. He was assistant secretary of the Treasury for international affairs in 1977-1981 and led the substitution account negotiations for the US in 1980.

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