October 23, 2021

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Stable coins’ rise has echoes of Bretton Woods

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Ousmène Jacques Mandeng is director of advisory boutique Economics Advisory Ltd and a Visiting Fellow at the School of Public Policy of the LSE. He currently works on a number of leading central bank digital currency (CBDC) projects and other blockchain-related payments applications. Here he explains why calls for stable coins hark back to the era defined at the Bretton Woods conference.

Fifty years ago, an embattled Richard Nixon dropped a monetary bombshell: the dollar would no longer be pegged to gold. The currency markets were thrown into chaos as the mechanism that underpinned fixed exchange rates was killed off overnight. The Bretton Woods era had ended and a new monetary order took shape.

Until now, it has lasted without serious challenges. For many currencies, floating rates remain the norm. Bar the euro, there have been no other major multilateral attempts to return to a system of fixed exchange rates.

But the introduction of so-called global stable coins by the private sector suggests there is still interest in returning to a Bretton Woods style monetary order.

The case for an international currency is as strong today as it was then, but remains difficult to implement.

To explain why, we need to delve into the political economy that has shaped the global monetary order. The Bretton Woods system emerged upon the initiative of the US during World War II. The idea was to establish a postwar framework of fixed exchange rates to facilitate a resumption of international trade considered critical for a sustained growth in GDP and jobs. Under the system all currencies were expressed in terms of the dollar or gold. The system was adopted in July 1944 at the United Nations Monetary and Financial Conference at Bretton Woods, New Hampshire, with the establishment of the IMF to ensure any revaluation of exchange rates had its approval.

The system had considerable successes. It followed the tradition of the gold standard, which in some variation or other was the international monetary standard from the last quarter of the 19th century (with interruptions during World Wars I and II) until Bretton Woods and can therefore be credited with laying the foundation of economic and financial globalisation.

However, while the fixing of all exchange rates endowed the international economy with a de facto common currency — and facilitated trade as a result — countries soon had to subordinate their domestic economic policies to maintaining the fixed exchange rates and the system showed considerable strains.

In 1965, criticism grew louder that, in particular, the US benefited unfairly as it was able to finance its external deficits with its own currency endowing it with what was described as an “exorbitant privilege”. Because the US issued increasing amounts of dollar debt also to finance the war in Vietnam, confidence sagged that it had enough gold to cover it. After different attempts to limit the dollar’s gold convertibility, during the early 70s persistent conversions of dollar holdings into gold caused a precipitous decline of US gold reserves. On 15 August 1971, the US decided unilaterally to close the “gold window”, ending the Bretton Woods system.

The idea underlying global stable coins is similar to that of fixed exchange rates: it rests on the conversion of national currencies into a third currency or basket of currencies. While there are different approaches, the most promising ones involve a floating rate common currency that circulates in parallel to existing national currencies. The supply of global stable coins would be a function of national currency tenders and convertibility into national currencies would be on demand at the prevailing exchange rates, respectively. Global stable coins need to be able to respond flexibly to positive and negative demand shocks. Defining the “optimum” currency or basket is complicated though and no attempt has been made to propose a single global stable coin amid the great variety of economic conditions across countries. Nor should it be.

Global stable coins are of course stable only until they are not. In the event of a sudden drop in demand, conversion into national currencies should in principle be straightforward as they are not constrained by wider economic policy considerations as typically national currencies would be. However, a very prompt move out of a stable coin could significantly reduce liquidity in that coin, precipitating conversion and possibly creating some depreciation pressure if doubts exist about its convertibility. Without any credit or liquidity mechanism, stable coins could leave holders stranded. For stable coins to serve as effective medium and instil confidence, some support mechanism would probably need to be in place to convey utmost trust in their convertibility.

We’re not about to overhaul the current system right now. Yet interest in global stable coins is indicative of a desire to overcome the limitations of national currencies and adopt a medium fit for international exchanges. It was a similar rationale that gave rise to the Bretton Woods system too. Earlier government-driven attempts like the IMF’s Special Drawing Right and the European Currency Unit have had mixed results. If that remains the case, the private sector may fill the gap.

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