Towards the ideal super-sovereign currency innovation

Editor's note: The author Yao Yudong is the director of the Institute of Finance of the People's Bank of China, and Yang Tao is the assistant director of the Institute of Finance of the Chinese Academy of Social Sciences. The author believes that network technology solutions or rules such as blockchain and RIPPLE are closely related to decentralized distributed currency and financial innovation. The core lies in creating a set of network-based, difficult to change, open and transparent "game rules". Therefore, relying on blockchain or other distributed ledger rules, a government may try to issue legal tender in a controllable scale and decentralized, so as to explore the possibility of integration between traditional legal tender and distributed and digital legal tender. It can also try to issue eSDR, and continuously optimize and improve it to build a new type of super-sovereign currency cross-border payment and settlement system, so as to appropriately alleviate the defects of the traditional monetary system dominated by sovereign currency, and also help to deal with the global "liquidity dilemma". This article only represents the author's personal views and has nothing to do with the author's unit.

The lack of effective rules and the evolution of new technologies have exacerbated the inherent instability of the existing international monetary system. To this end, we need to start from the rules and technology levels, and truly promote shared and win-win innovation at the monetary level with the development concept of shared finance. On the one hand, constructing a supranational monetary system has become a more attractive solution between ideal and reality, which can achieve the orderly supply and management of global liquidity. Although the SDR mechanism still has some shortcomings, it provides an important foundation and attempt for this effort. On the other hand, the various new types of electronic currencies that are currently surging have brought an impact that cannot be ignored on the real world and the financial world, and have become the de facto embryo of supranational currencies , which may be able to better realize the shared participation of transnational stakeholders under open conditions. In short, we can jump out of the existing SDR issuance mechanism that is stuck in a dilemma, and with the joint efforts of the IMF and member countries, explore the prototype of the mechanism of establishing a "global central bank" and try innovations based on digital electronic currency rules, namely eSDR .

Problem

Without currency, there would be no modern human civilization. A scholar said:

Money will decide the fate of mankind.

Keynes said in "A Treatise on Money": If we rewrite economic history with money as the main line, it will be quite exciting. We believe that the challenges faced by countries after the 2008 financial crisis have certain commonalities, that is, there are problems in the relationship between finance and the real economy, and international currency has become a "double-edged sword" that affects global economic and social development. With the continuous advancement of RMB internationalization and the opening of financial markets, my country is more closely linked to the global economic and financial operations. This requires a more detailed analysis and grasp of the deep-seated problems and technical forward-looking issues of international economic and financial fluctuations, so as to have a first-mover advantage and to a certain extent strive for the initiative in formulating international rules.

From the perspective of financial economics, asset price bubbles and large fluctuations, poor asset pricing mechanisms, uncontrolled cross-border asset value transfers, and urgent need to repair financial market infrastructure all constitute manifestations of crisis and risk. To get to the root of this, we need to dig deeper from the perspective of monetary economics, that is, the "inherent fragility" of the modern international monetary system is constantly increasing. This fragility comes from two aspects:

First, the concept of international monetary coordination under the Bretton Woods system has been "completely lost". The "currency chaos" after the Jamaica system has become the norm and has "intensified" since the beginning of the new century. Against this background, monetary policies of various countries often diverge, and monetary policy principles often deviate from global interests. The "dream" of global economic and financial integration in 2000 is "on the verge of bankruptcy" at the monetary level.

Secondly, the evolution of new technologies characterized by digitalization, electrification, networking, and informatization has already had a profound impact and shock on the monetary systems of various countries. This has not only affected the monetary transmission mechanism and policy effects, but also made the connotation and boundaries of the currency itself more blurred. The existing monetary theory and policy framework are also facing challenges. Under the conditions of an open economy, this has further increased the difficulty for central banks of various countries to use monetary policy tools to "target precisely", and they often resort to "extensive" operations such as "flooding" or "cutting off the source of funds".

It should be said that the lack of effective rules and the evolution of new technologies have exacerbated the inherent instability of the existing international monetary system. At the same time, to deal with the two existing fragile contradictions, it is also necessary to start from the rules and technology levels, and truly promote shared and win-win innovation at the monetary level with the development concept of shared finance.

Facing the “turbulent times” of the rules of the international monetary system

At present, the coordination defects of the rules of the international monetary system are becoming increasingly prominent. As we all know, the frequent international financial crises since the end of the last century have fundamentally subverted the original monetary rules, and the concept of competitive currency has become the mainstream. In this process, the changes in the strength of developed economies and the rise of emerging market economies have made it urgent for the international monetary system to change.

In theory, international reserve currencies should maintain stable value and fully flexible supply. Most importantly, their supply should be independent of the economic interests and conditions of a particular country. However, although the exchange rate in the foreign exchange market can reflect the supply and demand relationship between different currencies, it is still inseparable from the monetary policy choices of developed economies, and these economies use domestic economic conditions as the main policy determinant, and the existing international reserve currencies are no exception.

In this regard, on the one hand, in essence, the international liquidity provided by sovereign currency countries is equivalent to their own leverage, and there is an upper limit to the leverage space of both the private sector and the government sector. Therefore, in the long run, the liquidity supply of the sovereign currency system is limited, and it will be constrained by the domestic economic conditions and liquidity supply capacity of the reserve currency country. This inherent constraint, while causing turbulence in the international financial market, also causes the structural shortage of global liquidity and the accompanying deflationary trend, which is the "liquidity shortage". From this perspective, the sovereign international monetary system is only a Pareto improvement to solve the "Triffin dilemma" and "liquidity shortage", not a Pareto optimality. On the other hand, when the "self-interest" rule is the first choice of monetary policy, it may also produce the "tragedy of the commons" of currency on an international scale. When economic bubbles appear or countries compete to get out of the "quagmire" of recession, liquidity overflow often becomes a common phenomenon, and once again lays the groundwork for the destructive crisis accompanied by a sharp liquidity tightening in the future.

Since the outbreak of the international financial crisis, the global economy has entered a profound adjustment period, the differentiation between different types of economies has increased, and the international financial market has been increasingly affected by the spillover effects of the monetary policies of developed countries. This has also triggered reflections on the current system and calls for reform, and has made many people begin to reflect on the rationality of the current monetary system, monetary theory and international financial order. It should be said that the construction of the international monetary system is a long-term issue, which requires the co-construction of mechanisms, win-win models and benefit sharing among developed and emerging economies. At a time when global liquidity may shift from "flooding" to "shortage", it has become more urgent to build new international monetary rules.

Clarifying the ideal and reality of supranational currency

Among the many coping ideas for solving the drawbacks of the international monetary system, there are the following representative views: First, some scholars represented by Professor McKinnon emphasize that the dollar standard itself has great flexibility, and believe that the future reform of the international monetary system should work towards improving the US monetary and exchange rate policies. Second, the supranational reserve currency plan proposed by Zhou Xiaochuan, governor of the People's Bank of China in 2009, believes that the SDR has the characteristics and potential of a supranational reserve currency, and the role of the SDR should be fully utilized in the future and the scope of use of the SDR should be broadened. Third, the reserve currency diversification plan, which was widely concerned when the euro was born, was later evaluated by many scholars as a more realistic path for the reform of the international monetary system. Fourth, some other "non-mainstream" views, such as returning to the gold standard.

It should be noted that, in essence, the reconstruction of the dollar standard and the reserve

The currency diversification plan still belongs to the category of the improved sovereign international monetary system. It can only be a short-term salvation. Returning to the gold standard is not realistic and it is difficult to truly solve the fragility of the international monetary system. Therefore, it is necessary to fundamentally and creatively reform and improve the current international monetary system. Constructing a supranational currency has become a more attractive solution between ideal and reality. By creating a supranational international monetary system that is decoupled from sovereign states and can effectively coordinate the interests of all parties and achieve win-win results, the orderly supply and management of global liquidity can be achieved.

The exploration of modern supranational currencies can be traced back to the 1940s. In the discussion on what kind of international monetary system to establish after World War II, economist Keynes envisioned the establishment of a global central bank, the International Clearing Union, to create and issue a new supranational reserve currency, bancor, which could provide sufficient payment and settlement media required according to global economic and trade development. However, with the support of the United States' strong comprehensive strength, the Bretton Woods system based on the "White Plan" was finally established, missing the opportunity to fundamentally solve the problem of global liquidity shortage and reform the international monetary system. Thereafter, in the process of responding to the dollar crisis in the 1960s, in order to supplement the shortage of international reserve currencies, the International Monetary Fund (IMF) adopted the Special Drawing Rights (SDR) program and began to issue it officially in 1970. In 1974, the IMF officially announced that the SDR would be decoupled from gold and replaced with a basket of currencies (16) as the valuation standard; in 1980, the IMF announced that the basket of currencies of the SDR would be simplified to 5 currencies, namely the US dollar, mark, yen, franc and pound sterling. After that, with the birth of the euro, the mark and the franc withdrew from the SDR basket, and the SDR currency basket became four, namely the US dollar, the euro, the yen and the pound. In fact, in addition to the euro, which is derived from the European Unit of Account (EUA) and the European Currency Unit (ECU), and has the characteristics of a regional supranational currency, only the SDR has the greatest potential as a global "super-sovereign currency". However, due to the limitations of its allocation mechanism and scope of use, its role has not been fully utilized so far, and it has remained in the form of an accounting unit. It should be said that the SDR does not meet the definition of a "freely usable" currency in the IMF Agreement:

1. Widely used in international transaction payments;

2. Widely traded in major foreign exchange markets.

Looking deeper into the reasons, the exploration of supranational currencies like SDR, although it has gotten rid of the situation where sovereign currencies are constrained by internal factors of a country, has also encountered political and economic "shortcomings" and constraints, such as: whether there can be a strong global ultimate credit support so that countries can use it as an international reserve asset and a means of payment of last resort; whether there can be a set of binding monetary rules to enable countries to jointly maintain the issuance and use of supranational currencies and share the responsibilities and rights therein; whether global investors can reduce their dependence on international currencies; and whether supranational currencies can be widely accepted in application scenarios such as trade settlement and financial transactions beyond the reserve function.

It should be noted that although the SDR attempt is in line with the development direction of the international monetary system, its efforts have been constantly faced with difficulties and challenges. The biggest difficulty is how to use effective monetary rules to reach consensus in the international monetary structure that has already moved towards diversification, promote the SDR to be further "grounded" and become a "freely usable" currency, thereby opening a "window" to solve the long-term and fundamental contradictions of the international monetary system. This requires continued efforts in strengthening the role of SDR as a pricing currency and settlement means, establishing SDR issuance rules, improving SDR allocation methods, and broadening SDR application scenarios. As Governor Zhou Xiaochuan put forward in 2009, the pragmatic suggestions. First, establish a settlement relationship between SDR and other currencies. Change the current situation that SDR can only be used for international settlements between governments or international organizations, so that it can become a recognized means of payment for international trade and financial transactions. Second, actively promote the use of SDR pricing in international trade, commodity pricing, investment and corporate accounting. This will not only help strengthen the role of SDR, but also effectively reduce asset price fluctuations and related risks caused by the use of sovereign reserve currencies. Third, actively promote the creation of SDR-denominated assets to enhance their attractiveness. Fourth, the valuation and issuance of SDRs should be further improved. The basket of currencies for SDR valuation should be expanded to include the world's major economies, and GDP can also be used as one of the weighting factors.

It can be said that the changes in technology and monetary and financial solutions in the digital age have provided a new perspective for this and helped to try out digital, supranational "shared currency" and "shared finance" models.

The Challenge of Electronic Currency to the Modern Monetary System

As the coordination of the international monetary system becomes increasingly difficult, the domestic monetary operation and policy mechanisms are also gradually affected by potential "disruptive" influences. As a starting point, we know that the British economist Hahn proposed the famous "Hahn Dilemma" in 1965, namely: Why does paper money with no intrinsic value have positive value in the process of exchanging with goods and services? The "new monetary economics" that emerged in the 1980s continued to deepen along this main line. The background of this analytical method is mainly that after the emergence and rapid development of electronic currency, there is a lack of effective support for the theoretical basis, so mainstream economists try to explore along the traditional theoretical research path. That is: if currency eventually disappears; legal tender is no longer the only medium of exchange, and is eventually replaced by financial assets issued by the private sector that generate monetary returns; or currency is fully electronic. Then, how will we describe a monetary economics without the premise of traditional monetary assumptions? This is exactly the paradox and difficulty brought about by the new monetary economics.

According to the definition of the Basel Committee on Banking Supervision (BCBS), electronic money refers to a stored value or prepayment mechanism that completes payment through sales terminals, direct transfers from devices, or computer networks. BIS conducted a series of studies as early as 1996 and believed that electronic money may affect the monetary policy of the central bank, such as affecting the relationship between the interest rate controlled by the central bank and the main market interest rate. Objectively speaking, on the one hand, the central bank has long had a monopoly on the right to issue currency, and also basically monopolized the right to issue major electronic currencies. On the other hand, it also brought a great impact on the theoretical framework of monetary policy, because the controllability, measurability, and relevance of "currency" are changing. Of course, with the rapid changes in new technologies, network currency forms that may be out of the control of the central bank have gradually emerged. The concept, scope, and transfer mechanism of currency are all changing. Among them, large and small amounts, banks and non-banks have caused profound impacts on different forms of currency and currency transfer, which is reflected in the impact on the quantity of money, prices, currency circulation velocity, money multiplier, and deposit reserve requirements.

To further sort out the development of electronic money, we need to start with the ultimate credit support behind the currency. First, the credit support of the most typical legal electronic currency either comes directly from the central bank of each country, or is directly supported by banking institutions, and the central bank provides indirect credit support based on the entrustment-agent relationship. Traditional electronic payment innovations represented by credit cards and the emergence of electronic wallets of financial institutions have not actually jumped out of the direct or indirect coverage of the central bank's credit. Second, with the development of e-commerce, more and more non-bank institutions are involved in the provision of electronic payment tools, which also brings new impacts on the structure and scope of currency. The connection between their ultimate credit support and the central bank has become weaker, so it has become the focus of supervision in various countries. For example, the European Union has specially formulated rules to regulate enterprises or any legal persons that issue electronic money as a payment method outside of credit institutions. Third, in the era of diversified network economy, virtual currencies with credit support provided by certain "network currency issuers" have also emerged. If these virtual currencies are ultimately used to purchase electronic products provided by program developers, then the real currency is the real medium in the transaction, and virtual currency has not formed an independent electronic currency. If virtual currency is not exchanged from the program developer and the counterparty is not the currency issuer (program developer), then this virtual currency is separated from real currency and independently performs its function as a commodity medium in the virtual world. Of course, due to its usually small scale, its impact on the real economy is not significant. Fourthly, although virtual currencies similar to Bitcoin have various defects, they are also the embryo of electronic currency entering the advanced state of digital currency. They are more and more relying on distributed rules and intelligent codes to issue and operate. Their credit support is getting further and further away from the centralized mechanism of the central bank. Although the scale is still small and the technology needs to mature, it may have a significant impact on the existing monetary mechanism in the future.

In any case, the various digital currencies that are currently surging have already had an impact on the real world and the financial world that cannot be ignored. They have also become the embryonic form of supranational currencies, and may be able to better achieve the shared participation of transnational stakeholders under open conditions. How to recognize, understand, adapt to and regulate their development, and welcome the leap from the IT era to the DT era in the transformation of monetary concepts and systems, has become a prudent and important historical proposition faced by regulators, academia and the industry.

The transformation of the international monetary system under new technological conditions

To promote the reform of the international monetary system, we can try to guide the development of digital currency from the international level as one of the ways to ease the contradiction. The basic logic is: the deadlock of insufficient global liquidity supply and international currency volatility is difficult to break. Since the influence of supranational digital currency is actually increasing, perhaps we cannot turn a blind eye to it. We should have the courage to face this and actively participate in and regulate its development, laying the foundation for exploring a more ideal path for the reform of the international monetary system in the future.

As far as a country's legal tender is concerned, its payment function is the most fundamental, while the medium of exchange, value scale, and value storage are subsidiary and variable. At present, all countries attach great importance to the optimization of the payment system. For example, in 2015, the Federal Reserve first issued the "U.S. Payment System Enhancement Strategy", calling on all relevant parties to seize the opportunity and work together to improve the payment system. The Federal Reserve believes that the reform of the U.S. payment system is at a critical stage. Technology is rapidly changing many elements involved in the payment process. High-speed data networks are ubiquitous, computing devices are becoming more and more complex and easier to move, and the timeliness of information processing is constantly increasing. These factors are changing the nature of business activities and the end-user's expectations of payment services. At the same time, as the basic elements that affect the public's confidence in the payment system, payment security and the protection of sensitive data are facing the challenges of dynamic, continuous and rapidly rising threats. In addition, more and more U.S. residents and businesses need fast, efficient and better payment options for daily transfers.

In view of this, the United States hopes that the reform of the payment system will achieve the goals of speed, security, efficiency, internationalization, and collaboration. Among them, "speed" emphasizes the rapid and final settlement of positions for payment clearing and settlement groups in a flexible and cost-effective manner, and supports universal, secure and faster electronic solutions required for various commercial and personal payments; "efficiency" emphasizes increasing the proportion of electronic payments, so as to reduce the end-to-end (social) average cost of payment services and transfer the value added by innovative payment services to consumers and commercial enterprises.

From this point of view, in order to better improve the efficiency of the national payment system, in addition to improving the existing mainstream model, the new digital currency and payment settlement model also brings new opportunities and challenges. On the one hand, the distributed payment settlement model has gradually entered the mainstream vision. For example, the Federal Reserve's report mentioned that it is necessary to facilitate direct settlement between financial institutions based on the public IP network that uses common protocols and standards to send and receive payment information, because compared with clearing transactions through a hub-and-spoke network structure, the information distribution architecture between financial institutions based on the public IP network is likely to reduce costs. On the other hand, blockchain technology, which has been a hot topic of discussion recently, has attracted more attention from all parties. Its essence is a huge, network-based distributed ledger that can use consensus algorithms to transparently record and verify all transaction records without the intervention of a third party, which constitutes a certain infrastructure to support new currencies and financial transactions.

In fact, in addition to responding to the challenges of existing digital currencies, promoting the digitization of SDR based on distributed rules should also become an important attempt to reform the existing monetary system. It should be said that network technology solutions or rules such as blockchain and RIPPLE are closely related to decentralized distributed currency and financial innovation. The core lies in creating a set of network-based, difficult to change, open and transparent "game rules". Therefore, relying on blockchain or other distributed ledger rules, a government may try to issue legal tender in a controllable scale and decentralized, so as to explore the possibility of integration between traditional legal tender and distributed and digital legal tender. In this way, we can further embrace the bright prospects that electronic currency may bring in the future, such as: the reduction of social transaction costs, effective risk control, and the reduction of currency volatility. The ideal with a "utopian" color is that in a currency operation determined by network rules with extensive public participation and huge nodes, the endogenous disturbance factors of money supply and demand may be reduced, and money will be introduced into macroeconomic equilibrium analysis in a new way.

Further expanding to the global scope, if we can develop a more scientific, reasonable, non-sovereign, and network-distributed electronic currency, it will inevitably promote extremely profound changes in the international monetary system, monetary theory, and the international financial landscape.

We believe that we can try to issue eSDR and continuously optimize and improve it to build a new type of supranational currency cross-border payment and clearing system, so as to appropriately alleviate the defects of the traditional monetary system dominated by sovereign currencies and help deal with the global "liquidity dilemma".

Specifically, the SDR has not yet established an issuance preparation mechanism, and is still far from a true supranational currency. It is not only affected by developed countries based on international politics and interests, but also fundamentally constrained by the unstable operating framework of the IMF and the decline in its influence after the crisis. In this regard, it may be possible to jump out of the existing issuance mechanism that is stuck in a dilemma, and with the joint efforts of the IMF and member countries, explore the establishment of a "global central bank" mechanism prototype, and try innovation based on digital currency rules, namely eSDR.

In terms of principles, first, it relies on a decentralized currency issuance mechanism, anchors global economic growth and inflation levels, relies on program algorithms, and relies on nodes and terminals to operate autonomously; and constrains the supply of eSDRs through international rules. Fortunately, the first amendment to the IMF Articles of Association in 1969 has established an international legal basis for this. Article 18, Section 1 of the IMF Articles of Association on "Guiding Principles and Considerations for the Allocation and Withdrawal of SDRs" states that "the Fund shall make all decisions on the allocation and withdrawal of special drawing rights to meet the long-term global need and, when such need arises, to make up for the world's long-term existing monetary reserves, thereby promoting the purpose of establishing the Fund and avoiding global economic stagnation and deflation or excessive demand and inflation." Second, by building a set of open and transparent intelligent currency operation rules, a cross-border monetary credit consensus can be achieved. Third, participants jointly maintain the stability and sustainability of the system, and can gradually include central banks, financial institutions, and even non-financial enterprises and residents. The second amendment to the IMF Articles of Association clearly states that SDRs should be "the main reserve assets of the international monetary system." The "Framework for Strong Sustainable Balanced Growth" adopted by the G20 is also a precedent for international rules. Under this macro framework, combined with the "long-term global needs" of the First Amendment to the IMF Articles of Association, the Second Amendment to the IMF Articles of Association is implemented to establish the "Base SDR" as the growth target of the base currency of the global currency.

According to IMF regulations, the creation and general allocation of SDRs is based on the long-term global need to supplement existing reserve assets. Historically, the creation and general allocation of SDRs has only been carried out three times. The first allocation totaled 9.3 billion SDRs and was allocated from 1970 to 1972. The second allocation was 12.1 billion SDRs and was allocated from 1979 to 1981. The third SDR allocation of 161.2 billion SDRs was carried out in August 2009. It is particularly worth mentioning that in 2009, the third SDR creation and allocation played a key role in providing liquidity to the global economic system and replenishing the official reserves of member countries during the global financial crisis.

After 2017, when the quantitative easing by the Bank of Japan and the European Central Bank ends, the global liquidity shortage may be more obvious, and the eSDR can be issued to fill the global liquidity gap left by sovereign currencies. The exchange rate is not credible if the SDR does not enter the market. Compared with the SDR, the eSDR should try to expand beyond the reserve function and directly connect to application scenarios, such as expanding to payment and financial transaction pricing. For example, individual countries can be allowed to issue sovereign bonds denominated in eSDR.

We must also admit that in the "hot" new things such as blockchain technology, there are also rule design defects and a large number of speculators, which are full of risks and bubbles. It is urgent to "drive out bad money with good money" and it is also necessary to assist in the improvement of rules in the initial period with the help of "sovereign credibility". But what needs to be recognized more is that the Internet has formed a global, cross-border and smooth connection platform, which makes it possible to develop a global payment and clearing system based on public or proprietary networks, which is efficient and low-cost. The corresponding super-sovereign digital currency eSDR may also have a place on the international "currency stage" in the future, and improve in the direction of stable currency value, orderly supply, adjustable total amount, and detached interests, so as to maintain global financial stability and promote the development of the world economy, and make this innovative model led by rule and technological changes a functional supplement to the payment and clearing system of central banks of various countries and cross-border clearing organizations such as SWIFT.

As Milton Friedman said:

“Currency is too important to be left to the bankers at the central bank alone!”

The development law of currency can only be mastered by the future global central bank, which issues and manages supranational currency, to fundamentally maintain the stability of the global monetary system. Under the premise that the development of shared economy and finance has gradually become a historical trend, in order to cope with the inherent problems of the modern monetary system, perhaps we also need a "supranational currency dream" with insight and imagination.