Rise in stable coins echoes Bretton Woods
Sign up for myFT Daily Digest to be the first to know about cryptocurrency news.
Ousmène Jacques Mandeng is director of the consultancy boutique Economics Advisory Ltd and visiting researcher at the School of Public Policy at the LSE. He is currently working on a number of large central bank digital currency (CBDC) projects and other blockchain-related payment applications. Here he explains why calls for stable coins date back to the era defined at the Bretton Woods conference.
Fifty years ago, a struggling Richard Nixon dropped a money bomb: the dollar would no longer be pegged to gold. Currency markets were thrown into chaos as the mechanism behind fixed exchange rates was killed overnight. The Bretton Woods era is over and a new monetary order is taking shape.
So far this has gone on without serious difficulties. For many currencies, floating rates remain the norm. Apart from the euro, there have been no other major multilateral attempts to revert to a system of fixed exchange rates.
But the introduction of so-called global stablecoins by the private sector suggests that there is still an interest in reverting 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 shaped the global monetary order. The Bretton Woods system was born at the initiative of the United States during World War II. The idea was to establish a post-war framework of fixed exchange rates to facilitate a recovery in international trade seen as essential for sustained growth in GDP and employment. Under the system, all currencies were expressed in dollars or gold. The system was adopted in July 1944 at the United Nations Monetary and Financial Conference in Bretton Woods, New Hampshire, with the establishment of the IMF to ensure that any revaluation of exchange rates had its approval.
The system has had considerable success. It followed the tradition of the gold standard, which in one form or another was the international monetary standard of the last quarter of the 19th century (with interruptions during WWI and WWII) to Bretton Woods. and can therefore be credited with laying the foundations for economic and financial globalization.
However, while fixing all exchange rates provided the international economy with a de facto common currency – and thus facilitated trade – countries quickly had to subordinate their national economic policies to maintaining fixed exchange rates. and the system showed considerable strain.
In 1965, criticism grew that, in particular, the United States was benefiting unfairly because it could finance its external deficits with its own currency, which gave it what was described as an “exorbitant privilege”. Because the United States issued increasing amounts of dollar debt also to finance the Vietnam War, confidence declined that it had enough gold to cover it. After various attempts to limit the convertibility of the dollar into gold, in the early 1970s, the persistent conversions of holdings of dollars into gold caused a dizzying drop in the gold reserves of the United States. On August 15, 1971, the United States unilaterally decided to close the “golden window”, ending the Bretton Woods system.
The idea behind global stablecoins is similar to that of fixed exchange rates: it is based on the conversion of national currencies into a third currency or basket of currencies. While there are different approaches, the most promising involve a common floating rate currency that circulates alongside existing national currencies. The supply of global stablecoins would be based on domestic currency offers and convertibility into national currencies would be on demand at prevailing exchange rates, respectively. Global stablecoins need to be able to respond flexibly to positive and negative demand shocks. Defining the “optimal” currency or basket is complicated, however, and no attempt has been made to come up with a single global stable coin amid the wide variety of economic conditions between countries. It shouldn’t be either.
Global stablecoins are of course only stable until they are not. In the event of a sudden drop in demand, conversion to national currencies should in principle be straightforward as it is not constrained by broader economic policy considerations as national currencies generally would be. However, a very rapid withdrawal of a stable coin could drastically reduce the liquidity of that coin, precipitating the conversion and possibly creating some depreciation pressure if there is any doubt about its convertibility. Without any credit or liquidity mechanism, stablecoins could leave holders stranded. In order for stable coins to serve as an effective support and inspire confidence, a support mechanism will likely need to be in place to convey the greatest confidence in their convertibility.
We are not about to overhaul the current system at this time. Yet the interest in global stablecoins is indicative of a desire to overcome the limitations of national currencies and adopt a means suitable for international trade. It is a similar logic that also gave birth to the Bretton Woods system. Previous government-led attempts like the IMF’s Special Drawing Right and the European Monetary Unit have had mixed results. If this remains the case, the private sector could fill the void.