Wed, Aug 14, 2019
by Barbara Matthews
Barbara C. Matthews is a Bretton Woods Committee Member and Founder and CEO of a start-up technology company (BCMstrategy, Inc.), a fellow of the Salzburg Global Seminar, and non-resident Senior Fellow at the Atlantic Council. She exercised oversight of the U.S. participation in the Bretton Woods institutions when she served as Senior Counsel to the House Financial Services Committee. She has also served as the first U.S. Treasury Attaché to the European Union with the Senate-confirmed diplomatic rank of Minister-Counselor. She holds a B.Sc.F.S. from Georgetown University’s School of Foreign Service as well as both a J.D. and an LL.M. in Comparative and International Law from the Duke University School of Law. This blog post is a submission to the Bretton [email protected] initiative: a global dialogue to honor 75 years of economic progress and to revitalize the spirit of Bretton Woods now and for the future.
The 75th anniversary of the Bretton Woods Agreements has occurred in a year when cryptocurrency projects (including, but not limited to, the JPMCoin, Libra, Bitcoin, Ethereum, and various other StableCoins) are gathering momentum. This cannot be a coincidence.
Essays for the Bretton Woods Committee by myself, respected journalists like the FT’s Gillian Tett, eminent current and former policymakers such as Minister Shanmugaratnam, and advocates like the Chamber of Commerce have all agreed on a fundamental point: centralized mechanisms for managing cross-border policy coordination created by wartime command-and-control economies must evolve in order to remain relevant in a decentralized Distributed Age.
Alternatives exist. An increasingly broad range of economic actors have the technological means and sufficient financial support to “vote with their feet” and shift towards alternative (and potentially less transparent) mechanisms for transacting business, as the Libra proposal indicates. Significant shifts towards distributed ledger technologies and alternative token currencies at a minimum would deprive policymakers of critical information for monetary policy formulation. They could also erode further the thinning legitimacy of the Bretton Woods organizations.
Before declaring defeat, it is important to recognize that the upstarts from the cryptocurrency community seeking to unseat central banks have their own limitations. The technology driving issuance of alternative currencies may be new and different, but the issues they create are familiar to the multilateral economic policy community. Rather than competing in a fight to the death, both sides have much to learn from each other.
Currency Boards and Currency Baskets – Nothing New Here
Hubris among the electronic currency pioneers leads many to proclaim that what they are doing is without precedent. Let’s debunk that myth first.
Private sector issuance of tokens accepted as stores of value and media of exchange have a long and venerable (but not necessarily stable) history. When I visited there in 1999, the Central Bank of Oman’s museum in Muscat displayed a range of physical tokens accepted as money in this emirate across the millennia from sovereign and private issuers that stretched the known globe at the time (India, the Roman Empire, Egypt, Persia, etc.). Legendary bankers from Venice and Milan minted their own currencies, lending from London’s Lombard Street until the Bank of England was created. Banks across the U.S. frontier issued their own currency throughout the 19th century in the “free banking” era, contributing to considerable economic instability when those banks collapsed.
Currency baskets are not new either. Markets have long created – and traded shares in – currency baskets as a mechanism to hedge exchange rate exposures. The Special Drawing Right (SDR) issued by the International Monetary Fund is of course the grande dame of the sector. The other major successful official sector currency basket (the ECU or European Currency Unit) served as the precursor and effective pilot project for the euro.
Finally, currency boards have been tried and mostly failed throughout the 20th century. Examples include sterling’s ignominious exit from the European Exchange Rate Mechanism (ERM), Argentina’s problematic experience, and of course the U.S. dollar’s exit from the Bretton Woods gold standard. Hong Kong’s successful multi-decade success with a currency board suggests at least a small open economy with political stability can succeed. Current unrest in Hong Kong may yet test that currency board’s resilience. The history of holding a specific, fixed peg to an external reference rate suggests at a minimum that launching a currency board structure is not to be undertaken lightly.
Students of economic and monetary history and professionals in this arena understand well that any currency project depends first and foremost on credibility and trust afforded to the issuer. Markets migrate away from mechanisms they distrust. Migration can be gradual or volatile. Institutions that fail to adapt to shifting market sentiment can find themselves quickly on the wrong side of momentum, as the Bank of England discovered on the path towards ERM exit.
Innovations Requiring Evolutionary Responses
A wide range of economic actors increasingly seeks more efficient instant payments and a more inclusive financial system catering to the unbanked. In an increasingly politically polarized world, a growing number of economic actors also seeks an apolitical token as a store of value and a medium of cross-border exchange not issued by an individual sovereign. And in an increasingly barbell-like economy with a shrinking middle class, a growing number of economic actors seek better ways to channel funding to humanitarian and development needs as described in this Medium essay. These experiments in alternative currencies must be taken seriously, even when the rhetoric and hubris seem over-stated.
Many in the Bretton Woods ecosystem may view this as a threat, but the situation also provides opportunity for renewal and rejuvenation. Minister Shanmugaratnam and his Eminent Persons colleagues were right in October 2018 when they made the case for evolution by noting that the international financial institutions have a “unique ability” and established processes for identifying needs and delivering assistance. These multilateral entities provide a relatively transparent and accountable framework for identifying shared priorities which align with the most idealistic instincts of the Millennial generation. The SDR’s recent inclusion of the Chinese yuan and its multi-decade history as a de facto digital currency (albeit with limited distribution) suggests significant scope yet exists for innovation and evolution that meets a growing market need.
Policymakers have much to contribute to the cryptocurrency conversation. Distributed ledgers owned by private sector entities – and the currencies affiliated with those ledgers – could encounter difficulty delivering the transparency and accountability that civil society has come to expect from major economic agents. As my colleague on the Bretton Woods Committee Susanna Cafaro has rightly noted, accountability frameworks for multilateral organizations are far from perfect and continue to evolve.
Her logic (with which I agree) implies an important corollary: elected sovereigns are far more likely to respond to civil society needs than for-profit corporations whose duty of care formally extends only to shareholders. Even when a corporation chooses to prioritize grants and charitable donations (as the Libra Association has chosen to do), these distributions only occur after costs (including infrastructure investment) have been covered. Funding to cover global public goods like humanitarian relief and a broad range of development needs is only a mission-critical top priority for development banks and non-governmental entities like the Red Cross and Medecins Sans Frontiers. Blockchain-based currencies cannot change this alignment of interests and priorities even when they improve the efficiency of the payments mechanism and deliver insulation from corruption, graft, and misuse.
The challenges of maintaining a successful peg and supporting a sufficiently diverse, resilient, liquid secondary market are not insignificant either. Hard-fought experience could help inform diversification in the currency markets in a manner that delivers not just institutional evolution among the IFIs but also would help ensure that upstart currency issuers do not generate sources of instability for more established currency markets.
Policymakers are not passively watching these developments. Various respected central banks globally have spent the last three years exploring how best to adapt to the Distributed Age through central bank digital currencies. As my Bretton Woods colleague Ousemene Jacques Mandeng, the Bank of Canada, the National Bureau of Economic Research, the Bank for International Settlements, and others have rightly noted over the last two years, technological innovations provide central banks with additional avenues for distributing central bank liquidity even as they create the potential for novel (and potentially problematic) direct relationships with individuals that will place pressure on traditional central bank political independence.
This is not a Game of Thrones zero-sum video game. Electronic currencies hold the potential to change the supply and demand functions for currencies and for economic flows. In a technology-driven world, the binding constraints on supply and demand functions increasingly will be imagination and access to technology, not necessarily by the traditional components of economics (raw materials, labor, capital). Substantial shifts in motivation for economy activity beyond rent-seeking and the profit motive could also require deep re-thinking of how supply and demand functions operate. This is a rich vein to mine for both distributed ledger pioneers and their counterparts in the Bretton Woods institutions.
Both sides of the debate have much to learn from each other, for mutual benefit. History tells us that currency regimes tend not to evolve gently; they are prone to destabilizing ruptures. Such an outcome is not optimal for anyone. The opportunity exists at this juncture to think creatively and collaboratively about new horizons for economic activity. If the new leadership of the Bretton Woods organizations operate creatively and nimbly, they will lay the foundation for an evolutionary shift as significant as the one initiated in the remote New Hampshire mountains 75 years ago.