Herbert Poenisch: Multilateral Currency Systems for Reform of the Global Monetary System

2023-08-01 IMI

Herbert Poenisch, former senior economist, BIS.

Presently the global world is increasingly fragmented because of geopolitical developments. The leading role of the dollar is being challenged on a number of grounds, such as the privilege of the issuer of dollars, the dependency of the rest of the world on the whims of the US government and on their unilateral monetary policy decisions, such as raising interest rates. In addition, the war in Ukraine has added geopolitical concerns, such as the sanctions on Russia. Political urgency has been added in the recent meeting of BRICS foreign ministers in South Africa. They designated the New Development Bank to look into the possibility of a common currency.

A surge in projects to provide alternatives to the global dominance of the dollar confuses a number of issues. The first one is: will the alternative eventually replace the dollar or just be an additive. Secondly, digital central bank currencies are seen as panacea to solve these problems. They are only a technical instrument which cannot solve the underlying economic fundamentals, such as giving up monetary autonomy or fiscal sovereignty. Finally, it seems that the world is ready to accept any economic costs of an alternative because of political polarization. Even a relapse into bilateral clearing has become acceptable. Present bilateral arrangements and their subsequent problems will not be discussed here.

This article will first describe the present system with a number of global convertible and fungible currencies fulfilling the basic needs of a global currency, a common denominator, a universal means of payment and a store of value in deep and liquid markets. Secondly, it will address the experiments of regional currencies, first and foremost, the Euro. Thirdly it will present projects for alternatives to the dollar which are on the table now, such as the BRICS common currency project. Finally, a gradual move from bilateral payments arrangements to a multilateral clearing system based on European experience will be suggested.

1. Present multicurrency global system

The present global monetary system is the outcome of two world wars, when the then world monetary leader, Britain was financially ruined by these catastrophes and had to be saved by the new superpower, the United States. The Bretton Woods conference in 1944 established a new world monetary system with the dollar as lynchpin. This gave extraordinary privileges to the dollar, which the USA subsequently misused. It changed the rules in 1971 and keeps expanding the global money supply in order to serve its own needs. Regardless of the misuse, its share of foreign exchange trading for payments and private savings remains dominant at 88% (out of 200 % currency pairs) in the 2022 BIS foreign exchange survey. According to IMF official reserves in dollar still amounted to 60% at the end of 2022.

The first challenge to the system was the emergence of Japan in the 1980s as the second biggest economy. However, the Japanese government was too timid to allow the yen to become a global currency. It earned substantial current account surpluses but resisted to allow borrowing its currency to finance global borrowing needs. However, it retained a share of 17% (out of 200% currency pairs) of global foreign exchange trading, used for payments and private savings until now. According to IMF official reserves in yen still amounted to 5.5% at the end of 2022.

The next challenger, the EU was slightly more successful. It created a common currency, the Euro which was adopted by 20 of the 27 EU member countries. It was also accepted a means of payment and store of value by close trading partners of the EU. However, it ran into a deep crisis in 2011 because of uncoordinated fiscal policy among Euro member countries. However, it retained a substantial share of global payments and private savings, amounting to 31% (out of 200% currency pairs) of foreign exchange trading in the 2022 BIS survey. According to IMF official reserves in Euro still amounted to 20%.

The following section will outline the challenges in setting up regional common currencies.

2. Past projects for regional currency areas (RCA)

First, and logically prior, is whether abandonment of an independent monetary policy is desirable. Do the benefits of enhanced credibility, predictability and stability of the macroeconomic framework exceed the costs associated with the inability to tailor monetary policy to the circumstances facing a particular country? This question has stimulated active debate since the early 1960s, with the optimum currency area literature suggesting the following criteria for successfully forgoing a national currency: labour mobility, existence of fiscal transfers, symmetry of shocks and a diversified industrial structure. Unfortunately, these criteria are not very good predictors of actual currency regimes, suggesting that political and institutional factors are also important in explaining currency use. This is especially the case for regional currency areas (RCAs), which are often accompanied by, or the culmination of, other regional integration initiatives.

On the other side of the debate, it needs to be recognised that the theoretical advantages of monetary policy flexibility are often not attained, as monetary policy has in a number of countries been misused. In this context, RCAs, currency boards, and use of foreign currencies can be viewed as beneficial precisely because they remove the possibility of exercising monetary flexibility in a harmful fashion. However, such monetary arrangements were not a panacea that would guarantee credibility and stability. They could in fact break down if fiscal policy were not disciplined or if the economy did not exhibit sufficient flexibility. This explained the attention given to the limits on fiscal deficits in the euro zone, both as preconditions to entry and as an integral part of the ongoing surveillance embodied in the Stability and Growth Pact. The experience of Argentina shows that even the straitjacket of the currency board does not necessarily discipline fiscal policy, ensure wage/price flexibility or guarantee credibility. Some participants pointed to official use of a foreign currency as a regime preferable to a currency board, at least with regard to credibility. But there are costs, in particular a loss of seigniorage and the impossibility of making a steep change in the value of the currency to re-establish competitiveness.

A second important question, assuming that the first has been answered in the affirmative, is which of the regimes would be most suitable for a given country. As already noted, an RCA is most likely to emerge when there is already a strong sense of regional solidarity and other institutional manifestations of it. In the EU’s case, monetary union was the culmination of these other economic initiatives. There was much debate about whether this model is the only one, with a rough consensus emerging that it need not be. If it was to be successful and permanent, those other elements (customs union, macroeconomic coordination, harmonisation of taxes, removal of barriers to factor mobility, etc) needed at least to be constructed in parallel. While it was difficult to make a precise list of minimum requirements, in the absence of some of the other elements it was very possible that a negative shock would imperil the union by making it no longer attractive for one or several countries to remain in it. A currency board or unilateral use of a foreign currency was more likely to be the response to a severe problem of lack of monetary policy credibility, effective monetary institutions, or both. These two regimes also have the advantage that they can be put in place quickly. Several of the economies with such regimes had adopted them during crises. Though the conditions that had made such regimes necessary might disappear, exit strategies were typically not contemplated for fear of harming the credibility of the union.

A third important question concerns the necessity to put constraints on other policies, in particular fiscal policy. It is generally accepted that in RCAs uncoordinated fiscal policies may have adverse spillover effects. For example, over expansionary deficits that lead to unsustainable debt accumulation in one country can lead to higher interest rates or exchange rate overvaluation in other members of the union. In RCAs, this issue has generally been addressed through procedures for regional surveillance, with the EU’s Stability and Growth Pact being a prime example. While the advisability of such mechanisms is clear, there is ample scope for discussion concerning their modalities. Issues include whether to correct fiscal deficits for cyclical conditions, whether to exclude certain categories of spending or revenue, and how to ensure the achievement of convergence, eg through the threat of sanctions. As in other policy design, there exist trade-offs between the credibility and transparency of simple and uniformly applied rules and the flexibility that accompanies discretion to allow for each country’s unique circumstances.

3. Present proposals for multilateral currency arrangements

At present there are a number of proposals aimed at replacing the dollar in its dominant role in the world economy for trade as well as for store of value. However, this is a long shot, as none of the other currencies have the necessary qualities to replace the dollar. Any bilateral solutions are not sustainable as the perennial problem of what to do with trade imbalances. Russian Foreign Minister Lavrov complained recently about what to do with large surpluses of rupees, as nobody else will accept them. An institution like the Bank for International Settlements has to be set up, thus repeating the experience of the European Payments Union. At present the world cannot afford the inefficiencies of such a cumbersome system.

In addition, some of the candidate currencies such as renminbi and rupee do not allow free financial transactions to offset trade imbalances. Allowing such financial transactions would lead to the true internationalisation of currencies with a myriad of consequences for the domestic monetary policy. As the experience of Japan of the 1980s shows, such concerns put paid to the internationalisation of yen, which has never taken off.

The best which can be achieved at present is to establish an alternative multilateral payment system, which will be additional rather than replacing the dollar. The creation of the Euro for closely related countries in a geographical region, Europe is the most relevant experience. If like-minded countries, such as the BRICS countries envisage such a multilateral currency it will be additional at best, rather than replacing the dollar. If it aims to become a global payments and savings instrument it will have to include the other SDR currencies, dollar, euro, pound and yen or have some clearing arrangement with them. The prospects will be elaborated below.

The first idea for an alternative was propagated by PBoC Governor Zhou Xiaochuan in his speech in 2009, that the SDR would become a global currency, for payments and savings. The SDR has progressed by including the renminbi in the basket of 5 currencies. It has served well as a denominator, but the other functions, payments and savings are highly engineered and remain on an official level with lots of conditions attached to the usage of SDR. A country wishing to use its SDR as payment for trade has to contact other countries and ask for their agreement. Holding SDRs is limited to official holders. Making the SDR more fungible has been discussed but not yielded any operational results. The main obstacle is that the creation of SDR is a political process, by voting in the IMF.

At the same time four members of the Gulf Cooperation Council (Bahrain, Kuwait, Saudi Arabia, UAE, Oman, Yemen) took the political decision to peg their currencies jointly to the dollar, thus creating a common currency area. UAE and Oman did not join. As there was a lack of clear objective, the project was abandoned. It lacked any economic rational as trade fundamentals, such as trade with the EU were left out of the considerations. The present political push among BRICS countries repeats this approach.

Since then, creating central bank digital currencies (CBDC) has moved into the focus of research. One such project, mbridge would link digital currencies created by four different central banks, the Peoples’ Bank of China, the Hong Kong Monetary Authority, the Bank of Thailand and the Central Bank of the United Arab Emirates.

Project mBridge experiments with cross-border payments using a common platform based on distributed ledger technology (DLT) upon which multiple central banks can issue and exchange their respective central bank digital currencies (multi-CBDCs). The proposition of mBridge is that an efficient, low-cost and common multi-CBDC platform can provide a network of direct central bank and commercial participant connectivity, greatly increasing the potential for international trade flows and cross-border business at large. To test this proposition, a new native blockchain – the mBridge ledger – was custom-designed and developed by central banks for central banks, to serve as a specialised and flexible platform implementation for multi-currency cross-border payments. Particular attention was paid to modular functionality, scalability, and compliance with jurisdiction-specific policy and legal requirements, regulations and governance needs. The platform design ensures that mBridge adheres to the five overarching CBDC principles emphasised by the CPMI/BIS Innovation Hub/IMF/World Bank report to the G20 : do no harm, enhancing efficiency, improving resilience, assuring coexistence and interoperability with non-CBDC systems and enhancing financial inclusion.

Over the course of six weeks, the mBridge platform was put to the test through a pilot involving real-value transactions centred around the chosen use case of international trade. Significant groundwork was laid prior to the pilot, including extensive coordination within and among central banks and commercial banks, and tailored legal agreements and dress rehearsals, which ultimately led to its success. Between 15 August and 23 September 2022, 20 commercial banks from Hong Kong SAR, Mainland China, the UAE and Thailand conducted payment and foreign exchange (FX) payment versus payment (PvP) transactions on behalf of their corporate clients using the CBDCs issued on the mBridge platform by their respective central banks. The pilot advances multi-CBDC experimentation by settling real value directly on the platform and on behalf of corporate customers. Over US$12 million was issued on the platform, facilitating over 160 payment and FX PvP transactions totalling more than US$22 million in value. The pilot’s real-world setting also brought to light a range of policy, legal and regulatory considerations of a multi-CBDC, cross-border payments platform such as mBridge. Extending access to central bank money directly to foreign participants and conducting transactions on a shared ledger requires further exploration of policy, data privacy and governance considerations. A new, digital form of currency and a multi-CBDC platform also raise challenging legal questions that depend on each participating jurisdiction’s standing rules and regulations and may require regulatory changes to achieve full legal certainty and clarity. While some of these considerations can be addressed by the platform’s current design, others (such as BRICS) require further development and exploration.

With the range of technologies and models available, Central Banks require guidance to identify appropriate models that advance international trade, interoperability, financial inclusion and security. mCBDC platforms have great potential to address international trade settlement weaknesses. However, Central Banks have a deep interest in maintaining total control over the CBDC system and are hesitant to implement an mCBDC arrangement, with ownership distributed across the Central Bank network. Central Banks are also concerned about losing domestic control of monetary policy. Allowing a foreign digital currency within a country’s borders may result in consumers changing their preference for the foreign currency. The domestic currency then becomes underutilised. The Central Bank thereafter has less control over domestic prices.

All these considerations are included in a recent handbook for launching CBDCs by the IMF. The reasons for exploring CBDC differ somewhat between advanced economies (AEs) and EMDEs, however. Overall, CBDC work in AEs is driven primarily by the desire to maintain and strengthen the institutional underpinnings of modern monetary systems in the digital age, to promote competition in the payment systems, and to facilitate tokenization of finance. In addition to these considerations, CBDC work in EMDEs is also driven by financial inclusion-related motivations. Over the past two years, cross-border payment efficiency has become a more important motivation for CBDC work in EMDEs such as the BRICS countries.

Given the current economic climate, BRICS countries need to adopt radical measures to transform society to break out of the current economic hardships characterised by experiences of poverty, inequality, unemployment, weak trading networks and limited foreign investment brought on by the Global Financial Crisis, and the Pandemic. mCBDC arrangements offer a radical option to reimagine the global financial landscape. However, Central Banks will need to balance the need to drive economic growth with their concerns about sovereignty and ownership. Financial integration in the BRICS using integrated CBDC settlement platforms could become central in international finance and benefit economic growth through risk sharing, improvements in efficiency allocation, and reductions in macroeconomic volatility and transaction costs. With the emergence of national CBDCs, and trade and investment ecosystems developing within BRICS developing and emerging economies, the BRICS should seek to promote interoperability and common standards to ensure seamless international exchanges. Such standards can create more open systems, which allow for a level playing field for all stakeholders in the new system.

A more ambitious projects seeks to create a single currency for BRICS countries, called BRICScoin. It would play a role similar to the Euro, a regional currency rather than a replacement of the dollar. This proposal is driven by politics, such as in case of the GCC. There are possibly two versions: 1) A monetary union between the BRICS countries, creating a bloc similar to the eurozone. 2) A reserve asset based on the BRICS’ currency modelled on the IMF’s special drawing rights. One way this could work would be for each country’s central bank to be issued “BRICS currency” assets constituting a claim on the other central banks. For each central bank, the value of their new asset would be matched by the value of the liability formed by the other central banks’ claims. However, there a number of reasons why this might not work: the BRICS countries are not as closely integrated as the Eurozone countries were, factor mobility, such as labour and capital flows are severely limited, and structural imbalances exist, such as perennial deficit countries such as India and South Africa. Therefore, a gradual path from integrating bilateral payment arrangements into a multilateral payments system based on European experience is suggested.  

4. The way forward

Presently, the world is proliferating bilateral payment agreements without any serious challenger to the dollar. Common currencies such as BRICScoin are a distant objective without any idea how to move from bilateral to multilateral clearing. In the absence of this, the European Payments Union (EPU) offers the only cooperative real world example on how to bridge this gap. From 1950 to 1958 the EPU promoted multilateral settlements, encouraged the removal of trade barriers and cemented the stability of exchange rates. Participating countries agreed to accept the currency of any other member in payments for exports, instantly unsnarling the suffocating tangle of bilateral arrangements upon which the region’s trade had been based. Deficit countries were provided credits to finance temporary trade imbalances, obviating the need to restrict imports and, potentially, employment and growth.

There were five technical innovations: (i) bilateral balances were automatically offset so that each country had one single balance, debtor or creditor, towards the EPU rather than towards its individual members; (ii) balances were partly settled in gold or dollars by debtors to the EPU and by the latter to the creditors; (iii) the EPU extended credits to debtor countries, created from a fund created by surplus balances; (iv) a single unit of account, the dollar existed for all payments and credits; (v) the US treasury allocated USD 350 million as a start-up fund to cover temporary gold and dollar shortages in the multilateral settlement. The EPU was run by a managing board; the BIS acted as agent.

If indeed the BRICS countries have the political will to set up a regional multilateral payments system which would be an addition to the present global payment system, the following steps should be followed.

An organisation with the same mandate as the EPU has to be set up under the auspices of the BRICS. Balances will have to be settled in a denominator currency, such as the renminbi or gold. In this case, the GCC experiment becomes relevant as countries will be pegging to a common currency, probably the renminbi. This will imply aligning the monetary policy of BRICS countries with that of the PBoC. The strongest member of the group, China needs to provide a start-up fund to cover renminbi shortages in the multilateral settlements. An agent like the BIS would operate the system. At present it looks unlikely that China is prepared to take on such a far reaching global role with major implications for the domestic economy.

Literature used

Bank for International Settlements (2023): Blueprint for the future monetary system: improving the old, enabling the new. In: 2023 Annual Report Chapter III, www.bis.org

Bank for International Settlements Innovation Hub (2022): Project mBridge: Connecting economies through CBDC. www.bis.org/publications

Bank for International Settlements (2003): Regional currency areas and the use of foreign currencies. In: BIS Papers No 17 www.bis.org/publications

Financial Times (2023): The BRICcoin does not stand up, 10.May www.ft.com


Jadresic, Esteban (2002): On a common currency for the GCC countries. In: IMF Policy Discussion Papers PDP 02/12 www.imf.org/publications

Nelson Mandela University and Zhejiang International Business School (2022): Developing BRICS multilateral economic integration & Promoting trade and investment in BRICS with future cross-border Central Bank Digital Currencies (CBDC). Policy Report.

Ocampo, Antonio J (2019): The SDR’s time has come. Rethinking the Special Drawing Right could bolster the IMF’s role in the global financial safety net. In: IMF Finance and Development, December www.imf.org/publications

Poenisch, Herbert (2023): BRICS common currency would be no threat to the dollar., June, www.omfif.org

Tonioli, Gianni and Clement, Piet (2005): Central Bank Cooperation at the Bank for International Settlements 1930-1973. Cambridge University Press, pp327ff