From Bretton Woods to the Future: The role of digital money

UBS 30th Reserve Management Seminar 2024, Wolfsberg, 26 June 2024, prepared remarks

Dear conference participants,

I'm delighted to be here to speak to you today and am most grateful to UBS for the invitation. I will focus on the international monetary system, its history and lessons learnt, where I think the system will be going and the role digital monies may play. In addressing you the reserve managers, I'm of course addressing the operators of the system. I hope I will be able to provide some insights about the changes I believe the system will see over the short to medium term. I shall argue that the system will become more diversified by currency and by mediums which will naturally be reflected in a shift in the composition of foreign exchange reserves. The remarks are my own and do not necessarily reflect the views of Accenture.

I shall start with the Bretton Woods conference, as its 80-year anniversary is being commemorated this year, that of course set up the International Monetary Fund (IMF) and with it the system. I will refer to the IMF Special Drawing Rights (SDRs) as a needed reform but that had not the impact it was meant to have. I shall then focus on central bank digital currencies (CBDC) and other digital monies as a recent serious attempt to resume needed system reform and changes.

One of the main purposes of the IMF is to assist in the establishment of a multilateral payment system for current transactions to settle international trade and external interest payments. Such a system is one where many currencies are being used in international payments. This has not been achieved. I think it remains the biggest unfinished business of the IMF.

Most international payments continue to be conducted in a very narrow set of currencies. The IMF still today only considers 5 currencies—dollar, euro, renminbi, sterling and yen—as freely usable out of 145 currencies in circulation.

The narrow set of currencies useable in international transactions remains the most important challenge for the stability of the international financial system. It produces and perpetuates critical external vulnerabilities, in particular for foreign indebtedness. Without the ability to use their currencies in international exchange, countries will depend on holding foreign currencies that can. It is of course reflected in a relatively narrow composition and high level of foreign exchange reserves.

Key emerging markets like China but more recently India have indicated their interest in having their currencies play a bigger role in international payments. While the renminbi does count as freely usable currency, it has failed to gain meaningful traction in international payments. To play a bigger role, currencies need to be attractive. Digital monies, I believe, will play a key role in shifting the relative attractiveness of currencies.

Digital monies could be the electrical vehicle moment for the international payment system. The traditional mostly Western auto brands held on for too long on the tried and tested internal combustion engine. When electrical vehicles came along based on success factors different from conventional cars, Western firms had been slow to adapt and now risk being overtaken by firms a few years ago no one had even heard of. Similarly, the success of digital monies may no longer rely on the factors in particular large network effects that made the success of the still dominant currencies.

Bretton Woods

Bretton Woods was a unique moment in time projecting a most ambitious vision of an international monetary system based on multilateral cooperation. The establishment of the IMF provided for the first time a formal mechanism on exchange rates whereby countries abandoned their prerogative to adjust the value of their national currencies unilaterally. But, while Bretton Woods had a vision of a multilateral payments system, it may have set in motion, though some may argue merely formalised, a system based on a very narrow set of national currencies, notably the U.S. dollar.

Under the IMF Articles of Agreement, the treaty governing the Bretton Woods arrangement, all currencies were fixed to the dollar, at so-called par values, and the dollar was fixed to gold. Any change in par values could be made only after consultation with the Fund and any change greater than 10 percent required the consent of the Fund. This provided the legal basis for the centrality of the dollar. On 23 July 1944, following the end of the conference and publication of the Articles, the New York Times reported: “The American dollar thus obtains international recognition, on paper as in fact, as the world currency.”

But the dollar was not meant to become the world currency at Bretton Woods. Earlier documents serving as working documents towards the conference explored ideas of international currencies but never mentioned the dollar. They prominently included the ideas of U.K. delegation chairman at Bretton Woods, John Maynard Keynes, on bancor and of U.S. treasury official and main architect of Bretton Woods Harry Dexter White, on unitas. The Joint Statement between the U.S. and the U.K., a compromise between their respective proposals, released on 21 April 1944 laid the groundwork for an agreement on the IMF and introduced the concept of "gold convertible exchange," later modified to "gold convertible currency" in the working documents at Bretton Woods.

It would appear the dollar became the central currency at Bretton Woods by accident. In a meeting of Commission 1 [dealing with the International Monetary Fund] on 13 July 1944 a clarification question of what constitutes a gold convertible currency was answered as follows and led to subsequent changes in the working documents: “[I]t has been felt it would be easier for this purpose to regard the United States dollar as what was intended when we speak of gold convertible exchange.1

Delegates at Bretton Woods wanted all currencies to be used in international payments: “[M]eans must be found to increase the international liquidity of all countries, to give them assurance that temporary deficits in their international balances of payments can be met […] as one of the ‘primary objectives of economic policy’ […] so that each country can count on using the proceeds of its exports to any part of the world to pay for imports from any part of the world.2[…] If imports from countries other than the United States and the United Kingdom must be paid for in dollars and sterling, […] other currencies [will be] of limited usefulness in settling international payments.3

The concern that dependence on certain currencies would also have produced an overly skewed demand for those currencies and cause exchange rate instability was well understood and manifested itself in the scare currency clause of the Articles (Article VII). Yet the clause has remained ineffective.

Bretton Woods had the right objective but set conditions that provided an undue incentive to rely on the dollar. By making the dollar the anchor currency it made countries hold their foreign exchange reserves in dollars which in turn gave them reason to conduct their external payments in dollars. The share of the dollar in central banks’ foreign exchange reserves increased from 42 percent in 1950, to 53 percent in 1960 and 76 percent in 1970.

SDR

During the 1960s, the IMF became increasingly concerned about the slowing pace of reserve accumulation that would limit the capacity of countries to conduct international payments. Any rise in international reserves was mostly due to increased holdings of dollars and it was feared that the accretion of dollars will soon abate leading eventually to a significant weakening of the structure of international liquidity. In 1965, the IMF included as part of its work programme the need for the creation of additional reserves which culminated in 1968 with a report recommending modifications of the IMF Articles of Agreement to establish a facility for special drawing rights. In 1969, the amendment of the Articles became effective and in January 1970, the first SDR allocation was made.

The problem of using few currencies in international payments. had often been associated with Robert Triffin of Yale University and the Triffin dilemma. Triffin was concerned that using national currencies was a “built-in destabiliser” as the supply of national currencies may not necessarily be aligned with the needs of the international economy. His insights have helped advance work on the SDR.

The SDR was an international reserve asset issued by the IMF and exchangeable on demand for foreign currency reserves. It was to supplement reserves and eventually supplant them.

In August 1971, the U.S. unilaterally suspended the convertibility of dollars into gold. It brought the collapse of the Bretton Woods system—a complete disruption of the then existing monetary order—and resulted subsequently in the adoption of generalised floating of the main currencies. It triggered a rethink about the role of national currencies and the SDR.

In 1972, at the IMF Annual Meetings, then U.S. Treasury Secretary George Shultz outlined a plan to reform the international monetary system and end the special role of the dollar as a reserve currency. The plan included exchanging the dollar for the SDR to become the formal numeraire of the system, offering an exchange of existing reserve assets (dollars) for SDRs, eliminating the role of gold and transferring sovereignty to IMF to manage the system.

The exchange of existing reserve assets for SDRs was based on proposals for an SDR substitution account. There were different models including a compulsory exchange of foreign exchange assets for SDRs, SDRs in exchange of gold, an account administered by the IMF that accepts deposits on a voluntary basis of eligible dollar-denominated securities in exchange for an equivalent amount of SDR-denominated claims. In 1978, the Second Amendment of the IMF Articles of Agreement entered into effect providing among other for the SDR to become “the principal reserve asset in the international monetary system” and the demonetisation of gold.4

Yet, the SDR never took off and fell subsequently into disregard attracting only very limited interest during most of the 1980-2000s amid a perceived lack of need to supplement existing reserve assets and concerns that further SDR allocations would be inflationary. There was no SDR allocation from 1981 through 2008. In 1980, the substitution account ideas were finally abandoned.

The substitution account failed amid a lack of sufficient agreement on the parameters governing the substitution. It is indication that large transformation projects in the international monetary system are difficult to implement.

International monetary system today

The international monetary system has evolved somewhat. Earlier concerns that there may not been enough reservable assets seem unfounded. Foreign exchange reserves increased from US$2 trillion or 6 percent of world GDP in 2000 to more than US$12 trillion in 2023 or 12 percent of world GDP. However, after significant increases in foreign exchange reserves since the 2000s, the pace of foreign exchange reserves accumulation has slowed markedly. Since 2022, there has also been renewed significant accumulation of gold in central bank international reserves.

The composition of foreign exchange reserves has changed quietly. The share of the dollar fell from 71 percent in 2000 to a new local trough of 58 percent in the last quarter of 2023. There had been increases in particular in non-traditional reserve currencies including but not limited to the Austrian dollar, Canadian dollar and renminbi. This may point to some incipient meaningful diversification in international currency usage.

But the system continues to shun emerging markets currencies. The integration of large emerging markets into the international economy had not been accompanied by their currencies. It led to a historically unusual situation where large countries have maintained dependence on third country currencies for conducting international transactions. While China and emerging markets represent nearly half of world GDP, their currencies continue to represent only a small fraction of foreign exchange reserves.

The future or forward to the past

The future of the international monetary system should look quite different from the past. Yet, it shall aspire to the intent at the beginning of the system which is to establish a multilateral payment system. The opportunity for many currencies to serve in international payments, it will be assumed here, shall bring greater balance and strengthen incentives to conduct policies with a view of external stability. It shall rest on the relative erosion of the comparative advantage of conventional mediums.

The important innovation for the international monetary system is the adoption of new mediums. Central banks have been experimenting with CBDC for some time. The BIS in its 2023 survey affirms that more than 90 percent of surveyed central banks are engaged in CBDC work.5 CBDC shall denote here a new format of central bank money, a digital token, that is issued on blockchain and other distributed ledger technology platforms and offers new functionalities including programmability. It shall complement the existing central bank monies, that is, banknotes accessible by the general public and book-entry money or reserves accessible by banks and other financial institutions.

The innovation with CBDC is not that it is digital, most monies are digital of course. CBDC is not about how payments are being made but how they are being processed. At a high level, CBDC aims to replicate in the digital space the simplicity, transparency and velocity of banknotes. Banknotes are transacted peer-to-peer where payment is instant and execution is settlement. There is no need for other steps like clearing or netting or to reconcile payments across different ledgers and systems.

CBDC shall bring important efficiency gains and equip financial systems with new capabilities to meet actual and future payments needs. It promises to depend less on large network effects as transaction efficiency can be attained at lower volumes and in turn on other conventional success factors like market depth and liquidity thereby allowing to lower the barriers of entry for currencies to become efficient settlement mediums.

Recent initiatives like the BIS Innovation Hub project mBridge offer a new approach to facilitate international payments based on CBDC. mBridge is with the participation of the central banks of China, Hong-Kong SAR, Thailand, UAE and since May Saudi Arabia with 26 observer central banks and international financial institutions. The aim is for commercial banks from each jurisdiction to use a common platform to conduct cross-border payments peer-to-peer in all the CBDCs issued by the participating central banks. It is to promote use of local currencies in cross-border payments and as such offer an alternative to the conventional payment channels and use of third-country currencies.

mBridge rests on a combination of a change in central bank access policy and establishing direct payment relations. The project uses the same high-level architecture as CBDC project Jura of the central banks of France and Switzerland. Jura pioneered the outright use of CBDC to settle cross-border transactions providing a new architecture that changes the boundaries of central bank money in interbank clearing. It is conditional on central banks’ broadening access to central bank money to non-resident institutions.

The adoption of digital mediums will be a challenge. Currencies will be used if they are attractive. Adoption of CBDC may in large part depend on support by the issuing central banks. They will have to be some understanding that central banks will need to be pro-active to drive adoption to give confidence to banks that they can readily trade in and out of the CBDC. It may mean that central banks act as off-taker of last resort for foreign currency CBDC where local banks cannot or are not willing to carry foreign currency CBDC overnight. It would mean that central banks adopt foreign currency CBDC as part of foreign exchange reserves.

CBDC is one among many new digital monies. The emergence of tokenized deposits, tokenized money market fund shares and other stable coins form part of a new digital payments ecosystem. It will be the combination of all the different digital mediums that will support the national currency by offering different monies to serve different use cases denominated in the national currency.

To conclude, Bretton Woods has yet to deliver on one of its principal promises to establish a multilateral payment system. The biggest task will be to provide for the orderly integration of major emerging markets currencies as international currencies. Bretton Woods saw the advantages of a multilateral system but unwantedly produced too few incentives for such a system to emerge. The SDR, a radical idea for change, required too substantial and broad a consensus to achieve implementation.

CBDC and other digital monies may today be the most serious attempt to explore reforming the international monetary system. While the approach may appear to be less ambitious in scope of total country participation, it may offer a more viable path towards success. 80 years on, the future of the system may actually become more multilateral.

Thank you for your attention.