A New Reserve Currency?

By Steve Hynd

Could the dollar be sidelined as the world's reserve currency? It will, if China's head banker gets his way. The Financial Times reports:

In an essay posted on the People’s Bank of China’s website, Zhou Xiaochuan, the central bank’s governor, said the goal would be to create a reserve currency “that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies”.

Analysts said the proposal was an indication of Beijing’s fears that actions being taken to save the domestic US economy would have a negative impact on China.

“This is a clear sign that China, as the largest holder of US dollar financial assets, is concerned about the potential inflationary risk of the US Federal Reserve printing money,” said Qu Hongbin, chief China economist for HSBC.

Although Mr Zhou did not mention the US dollar, the essay gave a pointed critique of the current dollar-dominated monetary system.

“The outbreak of the [current] crisis and its spillover to the entire world reflected the inherent vulnerabilities and systemic risks in the existing international monetary system,” Mr Zhou wrote.

Although the FT says that the current system with the dollar as reserve currency isn't going to change anytime soon, Bernhard at Moon of Alabama is reading other sources that say China plans to bring up a plan to change the system at the forthcoming G20 meeting - possibly with support from European nations, Brazil, Russia , India and even the IMF, who have all recently backed the same alternative as the Chinese are proposing.

China will propose the new world 'currency' with reserve status, in fact a basket of major currencies as defined by the IMF Special Drawing Rights, at the G20 meeting on April 2.

It will take a few years until a full fledged SDR based system will become functional. The U.S. and the UK will likely fight against this. The Euro based countries will mostly be indifferent. For China this is now a major official policy goal. With BRIC pressing for a new reserve system and support from others medium weight countries like South Korea and South Africa the new initiative has a lot of momentum.

So far the U.S. could borrow cheaply and pay back less in real value than the original loan. That privilege is now going away. The trillions the U.S. currently needs to borrow from abroad will have to be payed back in full. That is a major change in its global power status and will seriously decrease its influence in international policy questions.

Thomas Mucha at GlobalPost writes that the Chinese premier recently went on record saying something needs to change.

Listen carefully to Chinese Premiere Wen Jiabao:

“We are very concerned about the economic developments in the U.S. economy,” the Chinese leader told reporters late last week. “We have lent a huge amount of money to the United States and of course we’re concerned about the security of our assets and, to be honest, I am a little bit worried.”

In the rarefied and reserved world of public diplomacy, this is a smackdown. It’s like your banker calling you into his corner office and saying: “Cool it on the spending. Now.”

The G20 summit is on April 2nd and if President Obama doesn't have a better plan than buying up toxic zombie assets and issuing a feel-good communique then he and his British ally might find themselves outvoted on a far more radical possible solution.

Comments

[Curmudgeon]

Wouldn't an SDR-based reserve currency imply (or require) a global bank to manage liquidity and to act as a lender of last resort during crises?

[Steve Hynd]

As I understand it, the Chinese plan sees the IMF and World Bank stepping into that roll, at least partially. From the FT article:

"Today, the value of SDRs is based on a basket of four currencies – the US dollar, yen, euro and sterling – and they are used largely as a unit of account by the IMF and some other international organisations.

China’s proposal would expand the basket of currencies forming the basis of SDR valuation to all major economies and set up a settlement system between SDRs and other currencies so they could be used in international trade and financial transactions.

Countries would entrust a portion of their SDR reserves to the IMF to manage collectively on their behalf and SDRs would gradually replace existing reserve currencies."

Regards, Steve

[Steve Hynd]

Kat just sent me this from the Gulf Times which confirms the IMF's role:

Zhou said the IMF, with its universal membership and mandate to maintain monetary and financial stability, had a natural advantage to act as the manager of its members countries’ reserves in the form of the SDR.

“This arrangement will not only promote the development of SDR-denominated assets, but also partially makes the management of liquidity in the form of the existing reserve currencies possible.

“It can even lay a foundation for increasing SDR allocation to gradually replace existing reserve currencies with the SDR,” he said.

Regards, Steve

[@robotsoul]

The desire to switch currencies was echoed at the recent BRIC summit. Additionally, the summit saw each nation contributing to the SDR kitty, an incremental step toward bolstering an SDR bond market. For more on the summit watch this: http://www.newsy.com/videos/making_cents_of_bric