Globe and Mail July 6, 2009
Calls grow to supplant dollar as global currency
France joins China, India and Russia in calling for a new reserve standard on the eve of the G8 summit
Karim Bardeesy
The call to find an alternative to the U.S dollar as the global reserve currency is gaining momentum as France joined calls by China, India and Russia for a review of the world's currency practices.
French Finance Minister Christine Lagarde challenged the dollar's supremacy “in a world that has changed because of the crisis and the growing role of emerging countries.”
The questioning of the U.S. dollar as the key currency for central banks by a leader of a major European economy gives renewed life to the issue at this week's Group of Eight summit meeting in L'Aquila, Italy. The U.S. dollar has long served as the dominant medium of exchange, and tends to dominate the official money reserves that countries hold through their governments and at their central banks.
In the first quarter of 2009, 65 per cent of the world's allocated foreign exchange holdings were held in U.S. dollars, according to the International Monetary Fund. That's the highest in seven quarters.
The push for an alternative is being driven in large part by concern over the weakened state of the U.S. economy.
The country is forecasting fiscal deficits for the next decade.
That's leading large holders of U.S. debt such as China to worry that the U.S. dollar may not be as safe as it once was. In addition, the dollar has been volatile on international currency markets, and the U.S. is running ongoing trade deficits.
Diversification would likely take years, because unwinding large reserve positions of U.S. dollars too quickly would devalue them. And despite concerns about the greenback, it has maintained its international appeal, in part because investors need the value of their U.S. dollar holdings to stay high.
With the U.S. continuing to require willing lenders to fund deficits, the situation has become what top Barack Obama economic adviser Lawrence Summers once dubbed “a kind of balance of financial terror.”
That U.S. Treasury bills appreciated in the immediate wake of the financial crisis was proof of the dollar's strength, as “people fled to a stable place,” said Paul Wachtel, a professor at New York University.
Still, the risk of a move away from the greenback is not without precedent, said Shaun Osborne, chief currency strategist of TD Securities. “The U.S. is a bit complacent about this. Most U.S. officials appear confident there will be no quick switch away from the dollar. But we have seen before, with the decline of the pound, that these things can happen quickly, in the space of years.”
Recent comments may be as much about politics as economics.
Large developing countries are seeking a greater role at the International Monetary Fund. China controls only 3.66 per cent of the votes at the body, despite being the world's third-largest economy.
“A little bit of nationalism, a little bit of searching for someone to blame for the economic crisis,” Prof. Wachtel said. “Plus, it's a changing world: diversification of reserves might make sense.”
Canada and Japan both reaffirmed their support for the greenback this week.
“It's an issue that we have not addressed, other than to say that in the midst of what is still a significant global recession, it's important that we aim for stability,” Finance Minister Jim Flaherty said on Friday. “The stability has been based on the U.S. dollar as the global currency.”
Whether and how this will actually come up at the G8 summit remains unclear. Russia is a G8 member, and China and India are set to join the discussions on the second day of the three-day meeting, but all are playing down the prospect of formal talks just yet.
Chinese Vice-Foreign Minister He Yafei said yesterday: “You may have heard comments, opinions from academic circles about the idea of establishing a super sovereign currency. This is all, I believe, now a discussion among academics. It is not the position of the Chinese government.”
The Chinese central bank, the world's largest external holder of U.S. debt, reiterated its call for a new international reserve currency in a policy review published last week. It has proposed an International Monetary Fund-created unit called Special Drawing Rights as an alternative reserve currency.
Regardless of what happens at the G8 summit, some analysts expect a diversification in large countries' currency practices.
Alternatives like the euro, yen, Chinese yuan, and Special Drawing Rights all have drawbacks, said Benjamin Cohen of the University of California-Santa Barbara. “A more fragmented currency system seems in the offing, with much competition and no money clearly dominant,” Prof. Cohen said.
With files from Bloomberg News and Reuters
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Washington Post June 24, 2009
Fading of the Dollar's Dominance
Other Nations See Opening to Boost Their Currencies
By Anthony Faiola
Washington Post Staff Writer
The days of calling the dollar almighty may be numbered.
Since World War II, when the dollar eclipsed the British pound as the king of world currencies, the United States has reaped the rewards of its monetary strength. The greenback's sense of indestructibility allowed the U.S. government to borrow cheaply and gave rise to an era of rich American globetrotters toting the world's most easily convertible form of cash.
But the financial crisis that started in the United States is dramatically intensifying the debate over the future of the dollar, and whether it can, or should, remain at the top of the financial food chain. Although a meaningful shift away from the dollar is likely to take years or more, some analysts believe that the debate is now reaching a tipping point.
Last week, the leaders of Brazil, Russia, India and China -- whose governments are some of the world's largest dollar holders -- jointly declared the need for a "more diversified international monetary system," sparking a drop in the greenback on world markets. In recent months, China in particular has led a campaign for a new world monetary order, arguing that the financial crisis has exposed profound vulnerabilities in the U.S. economy and financial system. Those flaws, critics argue, show it is simply too risky for the world's central banks to rely largely on the dollar for their global reserves.
At the same time, Beijing has taken unprecedented steps to increase the international role of its own currency, the yuan, to a level commensurate with China's relatively new status as a major economic power. In the coming weeks, the International Monetary Fund -- the institution charged with the monitoring and stability of the global economy -- will issue a vast amount of currency-like assets known as Special Drawing Rights, which some analysts see as a long-term substitute for the hordes of dollar reserves being held by central banks around the world. Some now envision that the dollar will fall from its recent levels of 60 to 65 percent of international reserves to less than 50 percent a decade from now.
A diminishing of the dollar's global role has far-reaching implications for the United States. The value of the dollar versus other major currencies could markedly drop as it slips from supremacy, making millions of Americans overseas feel poorer while potentially fueling a new golden era for U.S. exporters as American goods become more cost-competitive. The U.S. government may also be forced to pay higher rates to investors when selling, for instance, Treasury bonds to raise cash -- making it far more costly in the future to cover the kind of massive stimulus spending the government is now undertaking.
"The dollar's global status has allowed the U.S. to have a free pass on financing our deficit as opposed to countries like Brazil, who are punished by international currency investors for risky behavior," said Martin Weiss, author of the "Ultimate Depression Survival Guide." "But if the dollar is no longer the currency everybody wants or must have to continue doing business, that is going to be much, much harder to do."
Despite the current campaign to lessen the dollar's role, analysts note that there has not yet been a major push by foreign governments or private investors to shed it. In fact, over the course of the financial crisis, the dollar -- which had been on a downward trajectory for months -- has actually strengthened against major currencies, including its closest rival, the euro.
That is partly because even nations like China -- with the world's largest dollar-denominated reserves, at close to $2 trillion worth -- have shied away from dumping the dollar, fearing it could trigger a global run that would severely damage the value of their holdings. Additionally, other mighty currencies like the euro have lost their chance to claim the dollar's crown because their issuing nations are in even worse economic shape than the United States. In times of crisis, the dollar, as well as dollar-denominated U.S. Treasury bonds, are still seen as safe havens.
"The U.S. had to screw something up to lose the dominance of the dollar, and you could argue that the U.S. starting a global financial crisis is a pretty big screw-up," said C. Fred Bergsten, director of the Peterson Institute of International Economics and a top economic official during the Carter administration. "But the Europeans haven't been able to take advantage of that to advance the euro immediately, largely because they've made some pretty big screw-ups themselves."
That said, economists including Bergsten are now saying the end of the dollar's dominance appears increasingly inevitable. During the 19th and early 20th centuries, for instance, the British pound enjoyed a similar supremacy. It gradually lost that role as Britain's empire crumbled, was devastated by two world wars and saw the United States emerge as the world's dominant superpower.
By the same token, economists see the current financial crisis, and the doubts it has raised about the U.S. economy, as accelerating the creation of a new economic order. The easy monetary policy embraced by the Federal Reserve to spark a recovery -- including zero-interest rates and the printing of cash to support stimulus spending -- is also working against the strength of the dollar.
"The dollar may very well see periods of strength in the weeks and months ahead," said Douglas Rediker, director of the Global Strategic Finance Initiative at the New America Foundation. "But in the long run, I think it is clear that it will lose some of its hegemonic status."
This has left room for rising nations such as China to seize a broader role in the global monetary system. Though the Chinese currency remains largely non-convertible -- meaning it cannot easily be used in international transactions -- Beijing has taken steps to sign currency exchange agreements worth $95 billion with South Korea, Malaysia, Indonesia, Belarus, Hong Kong and Argentina. Brazil and China announced in May that they are exploring a similar agreement.
Though it may take years before such agreements have any real impact on the dollar, they are coming at a time when governments around the world may find another potential substitute for their dollar reserves: the IMF's Special Drawing Rights.
The SDRs are a currency-like asset whose value is based on the dollar, the pound, the euro and the yen. They have been issued by the IMF, albeit in highly limited form, since the 1960s to aid nations in need of reserves. In April, however, world leaders including President Obama agreed at an economic summit in London that SDRs should now be used to help stabilize the balance sheets of nations struggling to combat the current crisis.
As a result, the IMF is now set to "print" $300 billion worth of SDRs -- 10 times more than currently exist -- for distribution to nations around the globe. They will effectively be held as reserve deposits by each nation's central bank.
Some, like Bergsten, have argued the SDRs' role should be taken a step further, allowing them to serve as a de facto global reserve currency. Bergsten has advocated, for instance, the idea of nations such as China "trading in" their dollars for SDRs, allowing for an orderly transition away from the greenback without causing a sharp fluctuation in the dollar's market value.
"Like it or not, the dollar is going to lose some of its global status," Bergsten said. "So maybe it's time we just accepted that and figured out the best and most orderly way to make that happen."
