March 23, 2020
The Nation
In the regions hit hardest by Covid-19, we’re hearing heartbreaking stories of medical triage. From Central China to Northern Italy, stressed hospitals have been forced to choose between saving the lives of the old and the young, of parents and children. And in these tragic moments, we rely on the judgment of doctors, nurses, and the protocols of their local health systems.
But the virus has not only provoked a medical crisis. As the global economy grinds to a halt, it is also generating a historic monetary crisis, set to hit the poorest countries the hardest. In just two months, investors have sold off more than $80 billion in stocks and bonds from emerging markets, making it the largest capital outflow on record—three times that of the 2008 financial crisis.
With dollars draining out of the Global South, governments may soon find their finances in critical condition, unable to cover basic services like hospital care and essential imports like medical supplies—just as the spread of the coronavirus demands them most.
And with so much on the line, it is the Federal Reserve that has been charged with what we call monetary triage: deciding which nations will weather the crisis, and which will be condemned to suffer its gravest consequences.
The key to understanding this system of monetary triage is the dominant role of the US dollar in the global economy. In the era of the gold standard, governments tied the value of their currency to gold, keeping the precious metal in reserve in case paper money holders ever decided to cash in. But ever since President Richard Nixon ditched gold, the dollar has taken over as the de facto global reserve currency. Today, the majority of world trade is invoiced in dollars, and over 60 percent of all central bank reserves are held in dollars, accordingly.
When a crisis hits, foreign investors seek shelter in the dollar, evacuating their investments in “risky” emerging sectors and places. They sell their stocks in emerging market companies (India’s S&P BSE Sensex benchmark is down 26 percent, Brazil’s Bovespa stock-market benchmark is down 36), and they cash in their bonds from emerging market governments. Think of it as the “giant sucking sound” in reverse, as dollars flow out of the Global South and back into investors’ bank accounts.
The result of such an en masse retreat is catastrophic. Countries in developing regions like Latin America rely heavily on imports for basic services and sustenance, for which they pay in dollars. But with their reserves depleted and the value of their local currencies in rapid depreciation against a strengthened dollar, they are likely to face a “balance of payments” crisis that will severely constrain spending power. That will cripple their response to the coronavirus—a response that will require far more new resources than high-income countries that already have functioning health care systems and hospital capacity.
Simply put, not all governments can snap their fingers and magically afford an emergency health response, let alone provide a basic income to cover citizens’ daily needs. That is the privilege of the US and its sturdy, tradable currency. Many other countries, particularly those in the Global South, are dependent on the goodwill of their northern neighbor to keep them moving in such times of crisis.
That goodwill now comes in the form of a “swap line,” a monetary facility that allows the Federal Reserve of the United States to inject dollars into a foreign central bank in exchange for the local currency, with a promise to swap back once the crisis period has abated (with interest, of course: goodwill is never free). Swap lines were central to the US response to the 2008 financial crisis, sending billions of dollars to allies from Canada and Mexico to Japan and Singapore.
Now, with dollar access drying up, the demand for fresh swap lines is intensifying around the world. Historian Adam Tooze called it “the one thing that might save the world from financial collapse.”
The Federal Reserve is listening. Last week, it announced unlimited access to US dollars for five central banks from the Global North: the European Central Bank, the Bank of England, the Bank of Canada, the Swiss National Bank and the Bank of Japan. These are collectively known as the C-6. A few days later, capped swap lines were extended to nine more countries: Australia, Brazil, Korea, Mexico, Singapore, Sweden, Denmark, Norway and New Zealand.
Here, we return to the metaphor of monetary triage. Swap lines are the ventilators, allowing governments to keep their economies—and their citizens—alive. The Federal Reserve is the doctor, deciding which ailing patients it will choose to save from the mortal symptoms of economic crisis.
The key difference is that, unlike in Chinese or Italian hospitals, the Federal Reserve faces no shortage of swap lines: It is a simple matter of political will.
The injustice of the swap line system is obvious. No single country—no matter how exceptional—should have the right to decide who lives and who dies in the face of a pandemic. The coronavirus has revealed the profound principal-agent problem at the heart of our international monetary system: “The dollar is our currency, but it is your problem,” as Treasury Secretary John Connelly said back in 1971. The fact that the US government stands to profit from the interest rates on its swap lines is just salt in the wound.
But the swap line response is also strategically unwise. In a crisis of this scale and severity, we cannot wait for a single government to do the right thing—let alone the US government. The coronavirus has revealed that the design of the global economy has been far too brittle to accommodate such a shock, in trade as in finance. Our response must aim, therefore, to introduce greater resilience into the international monetary system. We simply cannot afford to have “one thing” that saves the world from its collapse.
The good news is that we already have an institution prepared to undertake this global response and an instrument to conduct it: the International Monetary Fund and its Special Drawing Right (SDR). The SDR is a reserve asset issued by the IMF whose value is determined by a multipolar basket of currencies: the US dollar, the euro, the pound sterling, the Japanese yen, and, fairly recently, the Chinese renminbi.
While on paper SDRs are promises of exchanges against promises of local currencies, in practice SDRs are akin to a global currency issued out of thin air and readily tradable for foreign exchange by a specialized department at the IMF. The SDRs issued since the 1960s have got little to no use since then.
When the 2008 financial crisis hit, the United Nations General Assembly (“G-192”), fueled by the Stiglitz Commission, called for solutions that helped those severely hit: the poorest economies around the globe. One of the decisions the G-192 urged on the IMF, technically a UN body, was the special issuance of SDRs. After the demand was reiterated by the G-20, in mid-2009, the IMF issued a special allocation of 183 billion SDRs that reached every country that was a member of the IMF.
The SDRs are distributed according to voting power at the IMF, so most of these assets were allocated to the richest economies. Only about $15 billion worth of SDRs reached all of Africa. However, for individual countries, these allocations were a huge relief. Unlike IMF loans, SDRs are not conditional on governments’ performance in terms of reducing public spending. Countries were able to cash those SDRs for dollars and were able to finance necessary imports.
In the case of the Democratic Republic of Congo, the injection represented over 800 percent of its reserves at the time. In the case of Gambia, it was over 30 percent of its foreign exchange reserves. While rich countries didn’t need to cash their SDRs, many poorer countries used them to alleviate their shortage of foreign exchange.
This precedent teaches us two humanitarian lessons for how to help the economies of the Global South amid the coronavirus pandemic. First, there are quick and viable multilateral alternatives that avoid monetary triage. Second, while SDRs may not seem worthwhile for the richest economies because rich countries already issue hard currencies, they may be critical lifesavers for the poorest ones. The global economy—indeed, our species—would benefit richly from avoiding waves of economic and viral contagion from vulnerable cash-strapped crisis-ridden countries.
While the size of the C-6 swaps are legally infinite, and these central bankers are loudly crying “whatever it takes,” the SDR allocation cannot be merely symbolic or marginal. We propose that the IMF quickly issue 3 trillion SDRs, a bit more than $4 trillion, for the entire global economy. We project the equivalent of around $250 billion that would reach African countries—a small amount out of the total, but still sizable relief. If rich countries can’t find a purpose for the SDRs received, they can donate their SDRs to those cash-strapped countries.
A global economy with vastly more SDRs would make the international monetary system much more resilient. Emergency funds would depend less on an unjust unilateral mechanism such as Federal Reserve swaps. Emergency inter-state humanitarian trade could be settled in SDRs without having to first exchange those SDRs for dollars at US commercial banks. And it would give the IMF a role of fostering pro-poor global economic growth rather than imposing austerity.
As the coronavirus begins its long march around the world, the need for multilateral cooperation has never been clearer. The IMF’s Executive Board must decide to go forward at once and avoid obstacles to such a cooperative approach. The fate of the world should not rest exclusively in the hands of the US Federal Reserve. We must act quickly to ensure it does not. Millions of lives hang in the balance.
