Rules versus discretion. What types of rules are needed?

The GSB should be constrained, to the extent possible, by clearly specified rules such as the ones described in the preceding section. In the design of the bank one needs to deal with the traditional dilemma between credibility and flexibility by taking a middle ground between rigid rules and pure discretion. This is normally the way this issue is addressed in the design of institutions and macroeconomic policies. Some intermediary point is always chosen since pure discretion and inflexible rules are problematic in practice.
Given the paramount objective of generating confidence in the currency, the GSB’s institutional design should rely more on rules than discretion. The bank could work in a nearly automatic fashion with hardly any discretionary power, while at the same time retaining enough flexibility to allow for short-term operational requirements and unforeseeable events.
What rules should be included in the GSB’s Articles of Agreement to ensure that the bank and its currency remain trustworthy? At least three major types of rules can be considered: i) those that safeguard the currency’s convertibility into the chosen anchor, already explained in general terms in the foregoing section; ii) those that guard against excessive creation of money; and iii) those that ensure stability in the NRC’s value. A further confidence-building rule could be to grant a measure of autonomy to the GSB’s Administration by establishing fixed mandates for the President and Vice Presidents, another feature that the NRC and GSB could share with contemporary currencies and central banks, as well as with most multilateral financial organizations.
Excess issuance could be avoided by establishing an upper limit to the supply of the currency, i.e., a ceiling for the total amount of NRCs and NRBs circulated by the bank expressed in nominal terms. Predefining a maximum issue helps to generate confidence in the currency. The NRC would have something that the US dollar and other currencies lack: a brake on issuance. The presently dominant currencies are created without any formal restraint, reflecting the priorities of the governments and central banks of the issuing countries.
The ceiling on issuance is of secondary importance, however. The main anchor of the currency would be the previously mentioned fiduciary backing of the currency, namely the rules that ensure full backing of the NRCs and NRBs by the predefined basket of bonds. Let us discuss these back-stopping rules in a little more detail.
The proceeds from each sale of NRCs or NRBs would have to be, as indicated, fully converted into the BoB. Thus, for each amount of liabilities in the form of currency or bonds the GSB would have on the asset side of its balance sheet the exact same amount of bonds of the participating nations. This ensures that the bank is capable of fully redeeming its liabilities in NRC or NRB on a one-to-one basis.
Under these rules, the size of the outstanding balances of NRCs and NRBs would be driven by demand, and not by decisions of the GSB. In other words, supply of the currency would be passive. If economic agents respond to a need for international currency by buying NRCs or NRBs, the GSB would supply automatically the assets demanded while using the proceeds to buy bonds. The sponsoring countries would be obligated in turn to readily supply the required amounts of bonds to the GSB, in line with the composition of the BoB.
The exact opposite happens, of course, if NRB and NRC holders demand redemption. In this case, they immediately receive, as explained earlier, a basket of bonds of the participating countries, at a fixed price and in amounts strictly corresponding to the weights of the basket. The digital records of the formerly outstanding NRBs or NRCs would be simply deleted on redemption. The balance sheet of the GSB would shrink: a reduction in NRBs or NRCs in the hands of the public on the liability side would be matched by corresponding reduction of the BoB in the hands of the GSB on the asset side. The remaining balances of NRCs in circulation and the outstanding NRBs would still be fully covered by the backstop in the form of a BoB, at a lower level. The exiting investors would be free to use the bonds as desired. Massive redemptions would of course signal a failure of the institution, given that its purpose is to maximize the amount of NRCs and NRBs held by the public.
One fundamental point needs to be highlighted: like all issuing banks the GSB would create currency “out of thin air” – a part of what Friedman in his later years called “the mystery of money”. This is why capital budget resources are not be needed for anchoring purposes. The cost of creating the NRC, digital credits for its holders and digital debits for the GSB, would be modest and limited to the indirect cost incurred in building and maintaining the new monetary system.
Actual holdings of currency by the public would be small compared to holdings of bonds, given that NRBs would be short-term and carry moderate, but still attractive interest rates, slightly lower than the average rates on the basket of bonds of the sponsoring countries.
The outstanding balances of NRCs and NRBs at face value would be equal to the face value of the amount of bonds that constitute the monetary anchor, as indicated above. However, since  the value of the bonds would fluctuate in secondary markets, the ratio of NRCs plus NRBs to the basket of bonds would rise or fall on a mark-to-market basis, with effective interest rates fluctuating accordingly. At secondary market values, the sum of NRCs and NRBs could thus conceivably rise above the value of the basket of bonds. This does not run counter to the GSB’s commitment, which is to be able redeem fully the short-term NBRs at face value on maturity. Gains and losses would be for those operating in the secondary markets, not for the GSB.
What is the operational role of sponsoring countries? While not called upon to supply capital for anchoring purposes, they need to commit to stand ready to provide their bonds to the GSB at the required maturities, with market-based interest rates. All these features should be spelled out unambiguously in the operational rules of the bank.
Countries would also be required, as mentioned, to provide a limited amount of capital in the form of bonds, at least in the initial phase of the GSB, in order to constitute a precautionary reserve. Later, as the bank generates and retains profits, this initial capital could be returned to the sponsoring countries. The GSB’s reserve can be expected be small, given that its only purpose would be to compensate for cost overruns, i.e., for losses arising from an excess of operational and other expenditures over net interest income. This is because, by design, the GSB would not be exposed to capital losses (nor benefit from capital gains), and its net interest income, also by design, would always be positive. To begin with, the precautionary reserve could therefore be simply defined as a fraction of operational costs. In a lean institution such as the GSB, operational costs would be small and easy to predict. Reserves would be drawn upon when the bank’s net financial income should fall short of operational and other expenses.

Stability of the NRC

Equally important is to guard against the instability in the value of the new currency. Since it would not be a currency for domestic transactions, but only an alternative currency for international purposes, it makes little sense to speak of inflation in NRCs. The relevant measure of instability would be the fluctuation of the currency’s exchange rate. Variations with respect to other currencies would reflect the weighted average exchange rate changes of its constituent currencies. The NRC would be a fluctuating fiduciary currency, like all major currencies since the last decades of the 20th century.
The question is whether there would be an excessive fluctuation that could undermine the NRC’s credibility as a reserve asset and usefulness as a unit of account. There are reasons to downplay this concern. Some are endogenous. First of all, China’s large weight in the basket of the NUA and the NRC has by itself a sizeable stabilizing influence, given the sustained stability of the renminbi. Moreover, some of the currencies and bonds included in the NRC and the NRB are of commodity exporting countries, others of commodity importers. In the example provided above, Brazil, Russia, South Africa and others are commodity exporters. China and India, with the largest weights in the basket, are commodity importing countries, at the opposite side of the commodity price cycle. In times of rising prices, the currencies of Brazil, Russia, South Africa and other countries tend to appreciate, while those of China and India tend to depreciate. In times of falling prices, conversely, the currencies of the first group would fall, and those of the second group would rise. These movements partly cancel each other out, favoring the stability of the NRC and the NRB.
If these endogenous stabilizing factors are not sufficient, as may be the case, one could generate additional stability by construction, i.e., by specifying exogenous stabilizing factors. To this end, the currencies experiencing excess volatility, i.e., depreciation or appreciation beyond certain predefined limits, could be temporarily excluded from the NRC. The relevant average would therefore be a symmetrical trimmed average. It might be preferable to specify this trimmed average as a geometric average, providing an additional factor of stability, since the variance of geometric averages is typically lower than that of arithmetic ones.
These factors taken together seem sufficient to ensure the required measure of stability. In any case, no specific nominal level for the exchange rate should be targeted for the NRC. Its value relative to that of other currencies would be automatically determined by the application of the formula. In other words, the GSB would not be running an exchange rate policy. Note, by the way, that the same stabilizing factors, endogenous and exogenous, would have already been incorporated into the calculation of the NUA, making it reasonably stable and thereby paving the way for some measure of stability for the NRC.  

Weak spots of the proposed monetary architecture and how to address them

What are the weak spot of the proposed monetary architecture? How could they be addressed and minimized?
There are basically three partly intertwined weak points: i) lack of confidence in the sponsoring countries; ii) China’s relative size and a resulting imbalance in governance; iii) the risk of Western backlash (sanctions and/or speculative attacks against the GSB). Let us consider these three points in turn, highlighting the links between them.
i) Lack of confidence in the sponsoring countries
Even with 100% coverage of the liabilities of the GSB, some lack of confidence in the quality of the back-stop provided by bonds of the sponsoring countries is to be expected. These countries are all middle-income nations with less than perfect fundamentals, a fact reflected in their sovereign credit ratings and in the premiums that their bonds carry over US Treasuries and Chinese bonds.
Nevertheless, this weakness could be addressed and compensated for in more than one way. The most important one would be to rely on China’s large share in the currency, the bonds, the backstop and the capital of the bank. With China inevitably accounting for the dominant share, confidence in the new currency would be strong, given the dynamism, stability and solid fundamentals of the Chinese economy. From this angle, the country’s size is an advantage. Having China play a large role is, however, a double-edged sword.
ii) China’s size and a possible imbalance in the governance of the GSB
One unavoidable problem is China’s disproportionate size compared to that of all conceivable members of the GSB. If we take relative size measured by GDP, no matter whether in PPP terms or in market rates, China accounts for 40% or more of any possible group of sponsors of the GSB. A high share for China, while undoubtedly generating confidence in the backstop and stability for the NRC, harms the internal governance of the bank. The GSB would become a China-dominated institution, with the other countries playing a largely figurative role. Thus, it is crucial to resort to specific mechanisms to restrain China’s share of votes and influence in decision-making, including basic votes and double majorities. The goal is to keep China large in the provision of bonds and capital, while at the same time limiting somewhat its voting power and influence.  
In any case, the GSB would be not only BRICS-centric, but also inevitably China-centric, given the country’s overwhelming size. No matter how you may play with the numbers, in the end China will have by far the largest share. The upside of this is, again, the effect of China’s weight on confidence. The downside – the overwhelming influence of the country in decision-making – can be dealt with, by establishing a different set of weights for voting power compared to the set of weights in the other baskets of the GSB, and complementing this difference by decision rules specifically designed to avoid conferring to China or a few large countries the ability to take decisions on their own, ignoring the views of the rest of the membership.
In this manner we could, counter-proverbially, have our cake and eat it too. China’s share of voting power and influence in decision-making would be kept lower than its share in the formation of the NRC’s anchor. Whether China will be inclined to accept this approach is a question to be considered in a moment.
iii) Risk of Western backlash
If the second weak spot – the risk of a non-inclusive, undemocratic governance – is addressed in such a fashion, this helps address the third – the risk of a US or Western backlash. This backlash can be expected to be all the more vigorous if the GSB were to be perceived as a mere facade behind which China, seen as the main rival by the United States, would be hiding. If the GSB has a more balanced governance, the risks of a backlash could be somewhat reduced.
Not eliminated, mind you. Far from it. Judging from the intransigent and aggressive behavior of the United States, the risks of reprisals would remain elevated, even beyond the term of the current US administration. The West can do a lot of damage, as we know from bitter experience. The construction of an alternative monetary framework requires initiative and considerable courage from the sponsoring countries.
They would be well advised to foster this courage. Under present trends, even if we were to remain silent and passive, nothing but instability, resentment and intimidation can be expected from the United States. We might as well rise up to the challenge and not fear bringing  forth ambitious and well thought out initiatives.
Could the West attack the GSB and the sponsoring countries? A coordinated attack to undermine the credibility and circulation of the NRC is certainly possible. This might include a speculative market attack plus official sanctions. Official sanctions could be applied in full knowledge that this would stimulate market players to exit from the countries targeted by the sanctions. Prominent among these market players are some gigantic Western-based hedge-funds, Blackrock and the like, that dominate international capital markets. These market movements could be orchestrated by governments and large investors.
The sponsoring countries would need to prepare, well in advance, a strong response to any sanctions and punishments, inspired perhaps by the effective defensive measures employed by China against the US in 2025. This means hitting back at the sanctioning countries and financial institutions in areas where they are more vulnerable. One can think of many such countermeasures, but I will leave this topic aside since an attempt to address it more carefully would lead us far from the purpose of this paper. Suffice to retain that the West, although still powerful, is no longer in a position to dictate. It is not only vulnerable in some respects, but would also be at pains to explain why an open and democratic monetary arrangement should be met with violent reprisals.

What stance could China be expected to take on the GSB’s governance?

A crucial question is the stance that China would take on such proposals. Would it take advantage of its size and reject a more balanced governance, despite the drawbacks that arise for other countries and even China itself?
Since the beginning of its rapid development in 1979, China has preferred to keep a low profile instead of taking the lead in international issues. It often encourages and inspires other countries to come forward as leaders of mutually convenient innovations. The explanation is straightforward. The Chinese have always been fully aware of the fact that spearheading initiatives will provoke resistance to proposals that interest them. While this may change, or may have changed already, China’s preference for a relatively low-profile behavior still seems to be there. Applied to the discussion at hand, a BRICS-centric new reserve currency, with a balanced governance, may be a better route to de-dollarization than large scale renminbi internationalization or an overwhelming role of the country in the GSB.  
One difficulty is political in nature. How could Beijing explain domestically the acceptance of a share in voting power that is significantly lower than its capital contribution and its share of the basket of bonds in the new bank? To put this question in perspective, a few considerations are in order. The GSB would be, for reasons explained earlier, an institution working in a largely automatic manner. Thus, voting would be less important than in institutions based more on discretion than rules, such as the IMF, the World Bank, and the New Development Bank. Moreover, given the bank’s mode of operation, also explained above, capital requirements would be modest and equally modest the corresponding capital budget expenditures for China and other members. Capital would be requested for the purpose of building a small initial precautionary reserve, and could be paid back gradually as the GSB generates and distributes profits. And, furthermore, if the bank were to be located in China, this would help the Chinese authorities make the case at home.
If China does not accept these arguments, it might try to impose an unbalanced governance on the other potential members. Conscious of the complexities of plurilateral negotiations and perhaps still unhappy about a lack of recognition of its special role, Chinese authorities could conceivably prefer to go alone, promoting aggressively the internationalization of its currency. On balance, however, this route does not seem attractive to China since it undermines some basic pillars of the country’s successful economic model, as discussed above. China may realize upon careful reflection that the new currency could function as a shield, deflecting external demand from the RMB and thus containing appreciation pressures and/or the need to accumulate additional undesired balances in dollars and euros, as well as exempting the country from the problematic step of further opening up its capital account.  

Can we do it?

Despite my attempts to keep the proposed monetary architecture as straightforward as possible, one might still go away with the impression that creating it will be rather demanding after all and could prove too tall an order for BRICS and other Global South countries, even for the larger and most developed ones.
I submit, however, that this is too pessimistic an assessment of our capabilities. After all, many of our countries have efficiently run financial institutions that are much more complex than the envisaged issuing bank. Many of the central banks of developing nations, for example, are highly sophisticated organizations that have been mostly successful in achieving their goals and fulfilling their mandates.  
In case the NRC is created and becomes a relevant player, we would have an entirely novel situation – for the first time in history, one major international currency would be a transnational currency, not a national or regional one. The system would not be run according to the priorities and criteria of a dominant or a few dominant powers, but to rules negotiated and defined by a plurality of countries from different regions of the world.
The dollar system may be at a tipping point. It is doubtful that it could withstand unscathed another financial crisis of great proportions. In 2008/2009, during the worst financial crisis since the 1930s, the dollar was paradoxically a safe haven, despite the fact that the crisis originated within the US financial system itself. This paradox will probably not hold anymore, at least not to the same degree. Nowadays, given the preexisting loss of confidence in the United States and the dollar, if another severe crisis does occur, as many economists and market analysts fear, investors (including central banks) will probably accelerate their flight from the dollar to safer havens – gold, other commodities, the renminbi, and other Western currencies. Prices of commodities, especially gold,  would rise even more, constituting perhaps yet another financial bubble. China’s economy would face a sizeable inflow of volatile portfolio capital, leaving the Chinese authorities with no good options, forced as they would be to choose from an undesired appreciation of the currency, foreign exchange intervention, the accumulation of additional unwanted reserves in the form of dollars and euros, or further accumulation of gold reserves at very high prices. Alternatively, the PBOC could impose barriers to the entry of capital, probably the least costly route, but paying the price of distancing the renminbi even more from full convertibility.  
As professor Radhika Desai noted, if a crash of the system were to happen, everyone would be scrambling for an alternative. This a good reason for putting ideas on the table, as I have attempted to do in this paper. Proposals perceived now as overly demanding, may look quite different if push comes to shove.
The approach suggested here drives at something new in the history of international monetary arrangements, while at the same time remaining grounded on the realities and practicalities of current international monetary arrangements. Hitherto, as mentioned, we have had national currencies (or a regional one, the euro) playing an international role on top of their domestic roles. But what we need is an international currency that plays no domestic role. That’s precisely what the NRC can be.
We are in a special moment in world history. The West is becoming less and less dependable. The United States and Europe seem to have lost their capacity to innovate and have fallen back into the business of stonewalling new initiatives, especially those that threaten, even remotely, their privileges and dominance. It will fall on us, countries of the Global South, particularly the larger and more developed ones, such as China, Russia, India, and Brazil to provide fair and inclusive solutions to the world’s problems.
If the West prefers to stay in the 20th century and remain attached to the institutions and practices of the past, this is truly regrettable. But let them stay there. We can move into the 21st century regardless.
Taking a very long view, the NRC could perhaps become the embryo of a new global currency, a step towards an all-inclusive international monetary and financial system. The current geopolitical splits, wars and rivalries make this a pipe dream for the time being. But who knows what can happen, say, in 30 or 40 years? A harmonization of geopolitical conditions, a meeting of minds from all corners of the world may allow serious practical consideration of a universal system that all countries of the world could take part in, a system to which the NRC might be a precursor. Thus, more than 100 years later, Keynes’ dream of a global reserve currency will have finally been realized.

Editor: LQQ