International Currency and the Power to Inflate

The International Monetary Fund (IMF) holds an imaginary currency called Special Drawing Rights (SDR) that acts as a currency reserve for other countries.  A reserve currency is held by foreign countries to purchase or sell their national currency in order to manipulate its value.  Recently, the dollar and Euro fill the role of reserve currency for 90 percent of global reserves.  The SDRs currently represent the value of the Euro, pound, dollar, and yen.  The basket of currencies is intended, in the rhetoric anyway, to stabilize the value of the reserve currency rather than putting control in the hands of a single government or central bank.  Russia and China are now pursuing the expansion of the program to include their currency and to increase the amount of SDRs available.

Before countries around the world left the gold standard, the “reserve currency” was precious metals.  If China and Russia are worried about the Americans inflating their money supply and devaluing Chinese or Russian assets, why not switch back to a gold standard rather than a basket of government controlled fiat currencies?  

To answer that question, imagine being in control of a country–any large nation in the world that uses dollars or euros as their reserve currencies.  This nation wouldn’t want another government or central bank having strong power over the value of their foreign currency holdings.  At the same time, this imaginary government would want the power to inflate its own money supply to reduce its national debt or just have more money available for more government spending.  Another advantage of SDRs is the inflation of our imaginary countries currency wouldn’t harm other countries that were using our currency as reserves as much as it might under our current system.  It’s not surprising that policy makers in the United States feel the same way.  

If Russia, China, and others are favoring the IMF’s SDRs, then they must prefer the power to inflate and take from the users of their own currency through seigniorage over the control over “reserve currency” that a gold standard would provide them.  

Government doesn’t want to give up its power to inflate the money supply because it forces fiscal responsibility.  Government has found ways to inflate the money supply ever since nations began moving away from commodity standards like gold–and many governments found ways to inflate before that.  Our Roots of the Crisis points out the explosion of inflation since the creation of the Federal Reserve System in 1913, FDR taking the country off the gold standard in 1933, and the closing of the gold window in 1971. 

If we want to stop inflation and insist on having government control the money supply, then we need to put the state on a commodity standard.  Let’s get back on the gold standard and we can stop the huge deficits that’ll result in much higher taxes or inflation down the road.