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Dreams of a dollar alternative

Finance Blogger: Anthony Harrington Anthony Harrington

There is nothing surprising about the Chinese getting irritated by the shortcomings of the US dollar as a global reserve currency. If you are a central banker, you don’t have to be Chinese to yearn for a massively deep liquidity pool that offers solid stability in value terms, rather than the high-octane, roller-coaster ride provided by the dollar. And if you happen to have a truly awesome balance-of-trade surplus, your desire for an untroubled value store for your incoming trillions is probably going to be pretty intense.

A good economist would probably tell you, if you bothered to ask, that you were barking up the wrong tree and that your best way of defending the value of your surplus lies in a different direction entirely—namely in working towards global trade balances so as to avoid stoking the fires of yet another global crisis (of course massively amplifying the dollar’s rearing and plunging).

However, given that the dollar has its shortcomings, it is probably inevitable that the Chinese, who are sitting on a mountain of depreciating dollar assets and who are watching the US Treasury rolling its printing presses with mounting dismay, are now openly pondering the question of an alternative global reserve currency.

In March 2009, Zhou Xiaochuan, Governor of the Chinese Central Bank gave a speech (see speech of 2009-3-23) which began with the question: “What kind of international reserve currency do we need to secure global financial stability and facilitate world economic growth, which was one of the purposes for establishing the IMF?”

In many ways this was a highly crafted question. It begins from the assumption that the dollar is, well, just not a contender, and it immediately puts the spotlight on the IMF as a likely, or possibly the only logical locus for an alternative.

In his speech, Zhou Xiaochuan began from the obvious standpoint that there are inevitable tensions in having the dollar both as a global reserve currency and as the national currency of the US. He then went on to cite the Triffin Paradox (named after the economist Robert Triffin) who pointed out back in the Bretton Woods era of 1960 that to be the perfect global reserve currency dollars must both flow both in and out of the US equal measure, an impossible act for a national government to pull off continuously.

A better solution, Xiaochuan suggested, would lie in a redesign of the IMF’s Special Drawing Rights (SDRs). His speech provides at least a sketch of how this could work, including a proposal that countries should create a settlement system between the SDR and other currencies, and that the rules regime for issuing SDRs should be thoroughly overhauled and modernized.

Once a settlement system was in place, he said, usage of SDRs would go beyond governments and “could become a widely accepted means of payment in international trade and financial transactions.” The basket of currencies forming the basis for SDR valuation would be widened to include all the major currencies, with GDP thrown in to the equation as well.

Some of the ideas in his speech were picked up by the G20 in April, which issued a communiqué saying that the IMF would be allowed to print $250 billion worth of SDRs, not exactly enough for a global currency, but enough for Ambrose Evans-Pritchard writing in the Daily Telegraph to hail it as “a revolution in the global financial order.” As 2009 draws to an end we remain a vast distance away from any viable alternative to the dollar as a global currency, but the debate has begun and it looks as if China, at least, intends to keep stirring the pot…

For a brief but telling analysis on why SDRs probably do not offer much of an answer to global imbalances see Texas University economist David Beckworth’s blog post on the topic.

Further reading

Tags: central banks , China , currency , dollar , financial crisis , global imbalances
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