The European monetary crisis explained
How the unique currency lead to difficulties for many countries of the eurozone. And why each country will inescapably return to a local currency for its domestic affairs.
by André Cabannes, PhD Stanford University, California, USA
August 2011, revised February 2012
We explain how the unique currency lead to difficulties for many countries of the eurozone, focusing on the example of Greece. The problem stems from a confusion between money for exchanges within a country and money for international trade. Greece is only the first in a series of countries where the same problem will arise: Italy, Spain, Portugal, Ireland, France. We do not advocate the withdrawal of these countries from the euro, but the use by each country of a system of two currencies, its local one and the euro. In recent decades China is the only country which applied the principle of separation of internal and external currencies and drew much benefit from it. Finally we explain why we believe that a new private international currency will appear.
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Table of contents
I The problem
II The solution
III What is money?
IV The critics
V The mistaken comparison between France and Germany
VI Greece revisited
VII The worldwide monetary problem, and its solution
I The problem
(forecast in June 2011)
(forecast in June 2011)
|GDP (billion euros)||236|
|Growth of GDP (%)||-4,5||-3,5||1,1|
|Budget deficit (% of GDP)||-10,5||-9,5||-9,3|
|Interest on public debt (% of GDP)||5,6||6,7||7,4|
|Budget deficit w/o interest on debt (% of GDP)||-4,9||-2,8||-1,8|
|Public debt (% of GDP)||143||158||166|
|Current account deficit (% of GDP)||-10||n.a.||n.a.|
|Unemployment rate (% of working population)||12,6||15,2||15,3|
Update November 2012 (gdp growth: 2011 -7% and not -3.5%, forecast 2012 -6% and not +1.1%)
sources: European Commission, Eurostat, Bank of Greece
Adoption of a common currency in Europe
In the 1990's the major European countries decided to have a common currency. They carried out their plan in two steps, first for business transactions in 1999, and then for all citizens, beginning January 1st, 2002. In broad outline, countries set aside the currencies they each were using and instead dealt themselves euros. From then on the eurozone had a single currency, a unique money. In the 2000's Greece and other countries joined the group. Greece undertook the same operation. It relinquished its drachmas and received an equivalent amount of euros. We explain at the end of the paper technically the issuance of a new currency, but what's important is the result: henceforth Greek firms and citizens could buy goods and services anywhere in the eurozone with their euros. Let's see how this lead to the present monetary crisis, and what is likely to happen next.
To understand the problem of Greece, we ought to distinguish monetary flows within the country from those across borders. They entail different accounting records, liabilities and problems. And within the country, let's focus on one very special economic agent, the government, the revenues of which normally come from taxes.
- Within the country: the Greek government kept its economic policy which consisted in spending more than it received from taxes and minor state entrepreneurial activities, and, in the past, printing drachmas to make up for its budget deficits. It amounts to a fiscal and monetary policy where tax revenues are produced with the printing press (producing bank notes or bonds). Some countries prefer this system to price stability, which has other advantages and drawbacks.
- Across Greek borders (1): The Greek government began to borrow euros mostly from foreign investors. Big European lenders (Société Générale, Deutsche Bank, etc.) were happy to lend to Greece, because the interest rate was high, to take into account the risk, and at the same time they knew that Europe would refund them should Greece fail. These were euros flowing into the country and corresponding promises to pay back later including some interests (= bonds) flowing out. Private Greek agents too borrowed within the country as well as abroad.
- Across Greek borders (2): in parallel to its budget deficits, Greece trade went into deep imbalance. Somehow the country indulged in a spending spree with its new money buying goods and services all over the world much more easily than with its previous drachma. Greece paid its imports in part with exports (tourism, textile, ore, food products, etc.), in part with promises, and in part with euros, which left the country.
The Greek State is nearing defaulting on its foreign liabilities, and it is running out of euros for domestic expenses. The eurozone, feeling concerned, hesitates on what to do. Should we abide by the liberal credo. Let Greece go under - what does that mean for a sovereign State? -, let's buy the Parthenon like China all but did with the Piraeus. Or should the eurozone act as a community, taking temporary control of the government of Greece? Angela Merkel opposes extending Greece further loans from the ECB and prefers to reschedule current payments due. Nicolas Sarkozy favors new loans in euros from the ECB, IMF, private banks or funds, because France and its own alarming twin deficits is not far from the situation of Greece. Jean-Claude Trichet, the head of the ECB and de facto of the eurozone, opposes rescheduling payments to private banks because it would amount to defaulting and trigger the same process all over Europe. He prefers a formal solution from the IMF (which means not much more than SDR movement entries in books kept in Washington) or, in opposition to his staunch stance until may 2010, that the ECB print yet more euros recorded as a credit in the liabilities of its balance sheet, or open new accounts in credit, to exchange with sovereign debt from a member of the eurozone, whose bonds would go as a debit in the assets of the ECB. Trichet buckled under the pressure of eurozone debtors. Notice that a bond purchase by the ECB, despite some medias sensational presentation, requires no particular effort from anyone in the eurozone. Yet it contributes to corrupting its money and prepares the ground for a monetary tsunami in Europe in not so distant a future.
Meanwhile, the Greek government began to reduce the salaries of civil servants, pensions of retirees and public spending. A growing number of Greeks don't have enough money for their everyday expenditures, and therefore shops and local producers suffer as well. The whole country is simply running out of the official money and its GDP has been decreasing for the last three years.
II The solution
What will happen next? - A local currency
When in a community there is a dearth of monetary means (to facilitate production, exchange and consumption), however, we can simply create some new ones ex-nihilo. It becomes a "local money". States (or Europe in this case) disapprove strongly of this because money is one the pillars of State power, although one could say that it is none of their business to interfere with the way a local community organizes its internal exchanges (see for instance household money). The emergence of local money happened in many places, and the phenomenon is accelerating at the beginning of the XXIst century, mostly as a consequence of the computer revolution. We foresee that it will happen in Greece. The Greek government will begin to pay its civil servants and state pensioners in part with something that may be called a "temporary system of vouchers", and for convenience it may write on them whatever name they like, for instance "drachma" or "eurodrachma" (introduced with an exchange rate 1€Dr = 1€ with the euro). These will be usable to buy goods and services in Greece, and it will be forbidden to refuse them. And if the government doesn't do this, it is even conceivable that some private outfit do it.
In a domestic monetary crisis, like Greece is experiencing, the population of the country is usually made bluntly aware of the problem when it becomes difficult to get banknotes from one's bank, even when one "has money at the bank". It happened for instance during the "corralito" episode in Argentina which began in December 2001 and lasted one year. Banks automatic teller machines limit the quantity of banknotes one can withdraw, because banks themselves have difficulties getting banknotes from depositors or from the central bank. Citizens of the country who are travelling abroad discover that their credit cards and their checks in euros are no longer accepted either. But in their country citizens can still draw checks on their bank account if it is in credit, that is if they have money at the bank. How is this possible?
The existence of this local money is possible because the bank deposits and the checks citizens can write have become a local money no longer "convertible" into real euros. In general the money created by secondary banks, to speak like textbooks, that is the loans opened in assets and the credits opened in liabilities of banks balance sheets, as long as they comply with the reserves limits imposed by the central bank, are a commercial-banks-created-money which, in normal circumstances, is convertible into real central-bank-money (sometimes called "high power money") and can be exchanged for banknotes on demand. But when this convertibility into banknotes no longer holds, the commercial-banks-created-money doesn't vanish. It becomes like any other non convertible paper money.
Said another way, when banks run out of euro banknotes in their assets, they still have accounts of loans and of reserves at the central bank in debit in their assets, and accounts of deposits from citizens in credit in their liabilities. These accounts can henceforth function as a system of signs (like the slate of a grocer's); there is no need that they be partially "guaranteed" by real euros on the asset side of secondary banks. People can write checks, and banks belonging to the same clearinghouse can make the appropriate entries in their books : if individual "a" draws a check on its bank A, and gives it to individual "b" (as payment for something received from "b"), then "b" will take this check to his bank B, which in turn will send it to C, the common clearinghouse of A and B. Finally the clearinghouse C will ensure that, on the liability sides of both banks, the account of "b" at B is credited the check amount, while the account of "a" at A is debited the same figure. And the opposite entries are made on the asset sides of both banks, in some other accounts, "reserves at the central bank", "private debtors", or any other appropriate account, but not "banknotes". This is a local money, formally denominated in euros, but these are no longer real euros, because they are not accepted abroad. They function only within the country. In the case of Greece, they can be called eurodrachmas.
III What is money?
Money is a spontaneous social phenomenon
Critics of the use of local moneys (bankers, high ranking civil servants, experts) forget that monetary phenomena are always and everywhere (to paraphrase a famous sentence) spontaneous social phenomena. Despite the scarcity of official monetary means, nothing can prevent the Greeks from organizing their production, exchanges and consumption somehow with a system of signs. That's what a money is. Why should Europe thwart it?
Most people still have a primitive understanding of money. They think of it as tangible value, which can be used or consumed, exchanged, moved, stored or stolen, like rice or valuable objects. They are shocked when they see a bank note being burnt. They believe that banks are places full of wealth. The name of the administration of the Treasury or the romantic stories about bank robberies seem to validate this view. People still think of money as when it was made of precious metals.
A bank however is nothing more than some sort of big accounting book. You can no more seize or destroy a bank, than you can destroy the information on a hard disk if there is a backup copy elsewhere. When people criticize the ability of secondary banks to "create money", even though some do it on informed technical grounds like Maurice Allais, in others we identify magical thinking at work: "money is gold, and its creation is the privilege of alchemists." But money is only a system of signs. In monetary questions matter doesn't matter. And you can no more "move" money, than you can "move" a promise you made to someone, from one place to another. (When you think you "move" money, for instance from one country to another, you actually exchange the promise you hold, change the people who made it to you.)
A second consequence of the perception of money as when it was made of precious metals is the incapacity to contemplate having several currencies at the same time in our purse (different currencies for the different communities we belong to). Yet this will most likely be the future. And when one thinks of it, it is very natural, just like we behave differently in different groups (family, town, country, abroad).
In any community where an explicit money doesn't exist, there is in fact an "implicit money". It has been studied less by economists than by anthropologists. They distinguish societies where top down power is totalitarian or strongly directive, from those where freedom exists but individual activities and behaviors are guided by customs. It is for instance the case of the "gift economy" studied by Marcel Mauss. But this would take us astray from our topic. In this paper we concentrate on explicit moneys.
Riots, Athens, February 2012
The medium within a community to facilitate its internal operations has nothing to do with, and should not be the same as, the one for its external trade. Had human beings the possibility to easily give their blood to buy stuff, we would observe some people running out of blood and dying. Fortunately nature saw to it that it be impossible.
If in a family where a household money system had been put in place to manage the chores, you saw that they were no longer done, and its members explained to you that "we cannot do the housework anymore because we ran out of euros to organize it among ourselves", you would think that you were dealing with fools.
Yet that is what is going on in Greece. The government reduced the salaries of civil servants, the pensions, the procurements. Therefore everybody's revenues and savings declined in the public sector as well as in the private sector. The whole economy is hampered by the lack of money. The "chores" are no longer done "because Greeks don't have euros".
In theory, it is possible to adapt a domestic economy to a shrinking quantity of money. It consists in lowering all prices. It is called internal devaluation. This makes the country "more competitive" (in plain language, its products cheaper) internationally, and helps improve its trade balance. In practice however it is extremely difficult to implement. Not all prices are easy to change at once. In particular rents tend to stick. Such a mechanism only brings further havoc to the problem it was trying to solve. The only realistic solution is via the exchange rate between the internal currency and the external one.
The situation in France is only slightly delayed. Presently we are in this preposterous situation: civil servants are paid with euros borrowed from Germany, instead of being paid with "slips of paper" issued by the French community. That is they give "promises of refund [by France at large!], plus interest, to Germany" in exchange for German euros, and they pay themselves with those. (The euro in truth operates exactly as if it were a German currency adopted by its neighbouring countries.) Meanwhile French car manufacturers, which build fine cars, have difficulties selling them because many people paid with borrowed euros prefer imports. French car plants operate below capacity and lay off workers. France is a net car importer. And the French public debt and French unemployment figures swell...
For another while the government can keep borrowing half a billion euros a day to sustain current economic activity. In January 2012, it lost its triple A rating from Standard and Poor's. We foresee that within a few months events will accelerate as in Greece.
One of the points of this note is the following: civil servants and other internal public expenditures of any community ought to be paid with the internal currency of that community.
This doesn't prevent those who receive the internal currency from using another one, for instance an international one too. But they will have to buy it from other people who hold some (from having exported). Any other system leads to dysfunctionnings like we witness in Europe at present.
This leaves us with the problem of defining "what is a community?". It is a problem deeper than economics. In fact, it is an idea that classical textbook economics and economists ignore blithely. As a consequence, their discipline is essentially useless to manage a community (just good to distribute Nobel prizes, to furious free marketeers in the last quarter of the XXth century, and to more liberal minded people in the XXIst century). And we are witnessing this ignorance of what is a community at work destroying many countries which make up what is called "Europe".
Each community of a group of communities should be left with the freedom to use at least two currencies: its own internal currency for domestic affairs, and the external currency of the group for exchanges with other members. If you believe that this sounds intricate or strange, observe though that it is exactly what Europe did: for its internal affairs it created the euro, and for its external trade it is mostly using another currency, for the time being the dollar. To think of several currencies in one's purse may be disturbing. Most people however would have only one: the local currency. The others would have currencies for trade which have no interference with the money regulating exchanges within the community to which they belong.
At present, having in our purse different currencies for the various communities to which we belong (city, region, state, eurozone, world) may seem intractable, and science fiction like. However when payments with our mobile telephones become generalized it will be very easy with modern database systems, managed by powerful organizations, to handle payments with a multiplicity of currencies by everyone (see multiple currency monetary systems).
IV The critics
The point of view of experts, lenders and European officials
- Experts clamor: "Greece will leave the euro", "It's a catastrophe". They do not explain precisely why, and seem to prefer witnessing the economic activity of Greece decline, street riots burst and poverty set in, but in accordance with a strict budgetary and fiscal policy within the eurozone, to seeing the revival of the Greek economy with a monetary policy adapted to the situation.
- Lenders are worried, for good reasons: there is a risk that they lose money on risky loans; to be more explicit, there is a risk that the principle "your profits are yours, your losses will be taken care of by Europe" be no longer applied. And they are opposed to the introduction of a local money in Greece, officially "because we must pursue the construction of Europe, etc.", in truth because this local money, which would restart the Greek economy, would make it even more doubtful that international investors be repaid fully their claims on the 350 billion public debt in euros. Hedge funds entered the game, buying second hand Greek debt at firesale price, betting that Europe will still give Greece the means to fulfill all its obligations.
- Civil servants in Brussels and big countries are indignant: "We are unraveling the construction of Europe!". Generally speaking, they look at the future with intellectual frameworks of the past, in the same way in the 1920's the big powers desperately attempted to go back to the gold standard with the dire consequences of the 20's and 30's. For instance in 1925, Churchill, then Chancellor of the Exchequer, following the recommendation of experts lead by Montagu Norman, set the value of the pound sterling back to1 troy oz 11/12th = £3 17s 10½d (the exchange rate set by Newton!) hurling Great-Britain into six years of depression. Likewise European officials are focusing on the construction of the United States of Europe and such likes, when, in our opinion, the future belongs to networks, on the model of families making up a city, of much smaller autonomous communities than present day heterogeneous nations inherited from the XIXth and XXth centuries. Our view is not as new as may appear: even Montesquieu argued for republics of small sizes. They would use a local currency, and one or several currencies for trade in higher level groups.
Bankers will say that returning to local currencies is crazy and impossible to implement, but let's not be overly impressed. Over the past few years, they created the so-called subprime loans, packaged them, sliced them, securitized them, and resold them to investors all over the world, and the latter finally incurred losses estimated by the Bank of International Settlements at four thousand billion dollars.
Scholars did study something they christened an optimal currency area, and speculated whether the eurozone was one (or would become one). Suffices to say that Robert Mundell, who attached his name to the theory, successively explained that the euro was a good idea because the eurozone was an optimal currency area, and then that the euro would fail because the eurozone was not an optimal currency area. In the seventies, in Germany, a slogan making fun of the SPD went: "Like the SPD, be for and against nuclear power."
V The mistaken comparison between France and Germany
The case of Germany
In 1990, West Germany reproduced with East Germany the same mistake Churchill made in 1925. After the reunification, Germany decided to set the value of one eastern mark to one Deutsche Mark (the western mark). This was equivalent to going back to the gold standard with the overvaluation of the pound sterling when it was set to the same value of gold it had before WWI. The consequences were the same: East Germany (five new länder) went into a depression because its prices were suddenly to high. West Germany kept pouring money into its eastern part to try and compensate this phenomenon. To no avail: ex-East Germany is now a wonderfully equipped region with brand new freeways and other infrastructures but a weak industry. Germany spent more than a trillion euros in this pursuit, which explains a substantial part of its public debt.
It is tempting to compare the German and French debts (respectively 76% and 83% of GDP), but they have entirely different causes and structures. The French debt comes from a chronic fiscal deficit since at least the early 80's combined with a trade deficit for the last seven years, of the same nature as Greece's. Furthermore 2/3 of France's public debt is held by foreigners (without counting French banks financing itself borrowed from abroad), when Germany's public debt is more internal. And Germany on the other hand has had for years one of the world strongest trade surplus, which lead it to lend euros and dollars. France will experience the same problems as Greece, while Germany won't.
VI Greece revisited
Greece is not leaving the euro
Greece will still use the euro for its exchanges with other countries in the eurozone. But it is crazy to choke the domestic economy of Greece by imposing on the country the use, for its internal activities, of an external currency, the quantity of which owned by Greece decreases. And it is no less crazy to try and solve the local problem of Greece by corrupting the global money of the eurozone.
True, Greece has big debts in euros to foreign creditors. But it's not by strangling the activity within Greece that their repayment will be facilitated. True, Greece will have to pay back its debts (after renegotiation) with euros. These are euros Greece will earn, like everybody else, with exports. Reducing the salaries of civil servants in Greece or imposing to the Greek fisherman that he buy his bread from the Greek baker with the international currency will not help the country gain more euros.
On July 21st, 2011, the heads of the seventeen eurozone countries after several heated meetings to decide what to do reached an agreement. They opted for a traditional solution: to grant a further 158 billion euros to Greece, coming after the 110 billions granted last year. They'd gotten their calculations wrong last year? The new package comprises IMF help, ECB purchases with euros wet from the printing press, payments rescheduling, new Greek debt guaranteed by the whole eurozone, etc. The finance ministers presented this as a historical solution to the Greek problem. In our opinion, it is everything but that. It is only costly window dressing to buy more time for a moribund system. All the fundamentals described in this note remain and will inescapably lead to a local currency.
A very similar scenario unfolded in Argentina in the 1990's: currency board with the dollar, budget deficits, flight of dollars from the country, ever increasing loans from the IMF and other foreign lenders, and swelling public debt. When the credit tap was eventually turned off Argentina defaulted on $103 billion of debt. It lead to a surge in poverty and riots at the end of 2001. It also wiped out the savings of many small investors worldwide who had trusted the country (and the IMF). In January 2002, Argentina finally unpegged its peso from the dollar, which is equivalent to going back to a local currency. In the 1880's the same scenario of overgrowing Argentinian debt (that time denominated in pounds sterling) had already happened, and almost brought some big British banks to their knees. In the present Greek scenario, we are at the stage of ever increasing foreign loans.
After WWI during which the belligerents issued much paper money to finance their military efforts, the gold standard had collapsed. Europe main currencies were no longer convertible, and the price of gold had soared with respect to them, as well as to the price of goods and services. In Germany the mark lost all its value in 1923. In 1928, France invented the "Franc à quatre sous" (worth 20% of the Franc germinal in weight of gold). Great Britain, concerned with the loss of the strong credit of the pound sterling, decided in 1925 to return to the gold standard at the same exchange rate as before. Over the next few years this caused in England 1) an economic depression, 2) deflation, 3) a balance of payments imbalance, 4) a flight of gold reserves and subsequent costly borrowings, and 5) a surge of unemployment (up to 25% of the workforce in 1931). Eventually England unpegged the pound from gold, and devalued its currency. Replace gold standard with euro, the United States with Germany, and England with Greece, and you get exactly what is happening in the latter country in recent years. It is also happening in Ireland, Portugal, Spain, Italy and France, with governments and banks scrambling to borrow euros. We believe that in 2012, France will have to invent "l'Eurofranc à 70 centimes".
After the latest declaration of the ECB's president [Summer 2011] saying that the central bank will "reactivate its program of purchases of sovereign bonds in order to avert a European monetary crisis" (now to purchase Spanish and Italian bonds), let's observe that Europe is doing precisely what it reproached Greece for doing: printing banknotes to finance internal expenditures higher than internal revenues. It is legitimate to think that Jean-Claude Trichet, even if he will never publicly admit it, has accepted that the euro be scuttled, and eventually sink and disappear. As of August 15, 2011, the ECB has bought back 96 billion euros of sovereign bonds issued by Greece, Portugal, Ireland, Italy and Spain.
Between December 2011 and February 2012, the ECB also lent more than 1000 billion euros at interest rates close to zero to private European banks. Then the latter were invited to buy national government bonds. They did so at much higher interest rates, feeding a popular distrust towards European officials, banks, and national governments.
Greece still has euros, for its internal affairs as well as for foreign trade. The euros used for the domestic economy of Greece are a monetary nonsense. They can be purchased back by the government with "eurodrachmas". The Greek government may decree authoritatively that all bank accounts of Greek citizens in € are now bank accounts in €Dr. The euros gained by the government from this action will be used to pay the interests on the foreign debt and partially amortize it. In parallel to this preemption, all domestic contracts in euros will be rewritten into contracts in eurodrachmas. And foreign contracts will be renegotiated (as it has already begun). It is also the solution France will have to implement after the presidential election of May 2012, and other countries as well (Italy, Spain, Portugal, etc.). The euro will no longer be the domestic currency of various nations, and will become a currency used only for international trade.
There is a soft way to introduce the national currency we advocate, next to the euro: governments can begin to print and use a local currency in parallel to the euro. Civil servants would receive at the end of each month their salaries in part in euros and in part in the national currency. Which percentage? The percentage that would put an end to borrowing abroad in order to pay internal expenditures. This national currency would have legal tender status, and contracts between citizens would be payable in the national currency with the same figures. Remember that in 1797 England suspended for more than twenty years the convertibility of the pound into gold. Lord King asked the House of Lords to enforce that contracts denominated in pounds be still paid in their equivalent of gold calculated before the suspension of convertibility. But the upper chamber refused. The same applies today to Greece, Italy, Spain, France, Portugal and Ireland. This is the only alternative to going into a wall with eyes wide shut, hoping that "things will get better". In 2004, in France, the public debt was 1000 billion euros (half of what it is now), and we were already told that "measures were taken to reduce the deficit and the debt". How many more years shall we have to wait until governments act responsibly?
VII The worldwide monetary problem, and its solution
The case of China
In recent decades, China is the only country which understood and successfully applied the principle of separation of internal and external currencies. It used the dollar for its foreign trade and the yuan/renminbi for its internal affairs. It applied the separation principle in its strict version, taking measures to prevent the yuan/renminbi from becoming an international currency. After 1980, it became again a strong exporter (as it has been during most of history since Roman times). Its dollars were employed to import goods and services, to make foreign direct investments (in Africa for instance) and to buy foreign securities, mainly US Treasury bonds. Unfortunately these are likely to lose much value, and it is not a solution for the future.
China, like every other country on earth (except the United States), recognizes that the dollar cannot continue to be the world international currency. A new currency must be created that is not at the same time the currency of one country. Several solutions are possible. But China strongly favors a solution via the IMF. Why? Because it wants to get rid of the 3000 billion dollars of securities mostly denominated in dollars it holds (from its huge trade surplus of the last thirty years - it is likely, if you look around you, that many garments and other objects come from China), and wants to redeem them for another more trustful currency. If the international community were to adopt a new currency managed by a private outfit, it is unlikely that this outfit would accept the Chinese paper claims on the US and other countries. These would lose most of their value (they would become "American bonds", like the French know "Russian bonds"). Whereas if the IMF were to create a new international currency, more decisively than it did with the SDRs in 1969, it would issue it to central banks of countries in exchange for financial assets brought by these countries. And for a while the IMF would accept the Chinese holdings at a good exchange rate with the new currency. It is with this objective in mind that China secured the position of deputy managing director for Mr Zhu Min in July 2011.
The issuance of a new currency, be it by an existing financial institution (IMF, ECB or another central bank) or by a new one, is worth examining in order to better understand the nature of money. Let's look therefore at a group of countries (or any other economic agents forming a community for that matter) and a central institution which want to issue a new currency. The central institution can receive assets brought in by each country (other moneys, or gold, or securities, or assets) and give out receipts called bank notes (or just make entries in its books on the liability side, in the accounts of countries Treasuries, without even giving out slips of paper), denominated in a new unit of its choice. In this case the "value" of the assets brought in is important, and each country wants its own to be high. China wants its claims denominated in dollars to be recognized as having a high value. On the other hand the central institution may disregard any need for old value being brought in as a counterpart for new money issued. It may simply issue the new currency, recorded as a credit in its balance sheet, in exchange for inscriptions recorded as debits in its assets. These inscriptions don't even have to be viewed as promises, as is normally the case in operations of central banks. They can be arbitrary debits, corresponding to the arbitrary volumes of currency dealt to each country. These volumes may be proportional to GDP, to population, or as we saw to the value of assets "given" to the central institution. Moreover it is not important to be very accurate or fair in the distribution of the new currency, because any inaccuracy will only give a transient advantage or handicap to the country in question. Indeed, countries who discovered gold on their territory enjoyed only a fleeting advantage. Money is a vehicle to help goods and services circulate, that is to be produced, sold, bought and consumed. The only requirement is that this vehicle, or means, be trustable, reliable and well managed.
Maybe China's views will prevail and the IMF will issue a new currency, the main quantity of which will be granted to China. We believe however that in some future a new international currency privately managed by a firm (for instance an offshoot of Google) will be the trusted currency of the community of nations for their trade. The paradoxical situation, since Bretton Woods, of the dollar, being at the same time the sovereign currency of one country and the world international currency, will end. Like every monetary phenomena in history (with the exception of central banking in the XIXth century) the appearance of the new private currency will be inconspicuous, spontaneous, and overwhelming.
PhD Stanford University, California, USA