New global currency looks remote prospect


Sudip Roy
Published on:

But reserve currency diversification could be one upshot of the current crisis.

It is one of the great paradoxes of the financial crisis that while the private sector scrambles for dollars, central banks are stuffed full of them. Ever since the Asian financial crisis in 1997, central banks have rapidly accumulated foreign-currency reserves, principally dollars. Today, international reserves stand at about $7 trillion, of which 70% is estimated to be in US dollars. In contrast the total market value of treasury bonds outstanding, according to JP Morgan’s government bond index, comes to a face value of $2.6 trillion.

By placing their reliance on the dollar to such a degree, central banks have contributed to the financial crisis. By hoarding US treasuries, “central banks have left the market short of liquidity, management instruments and collateral,” says Ousmene Mandeng of Ashmore Investment Management.

The irony is that this vast accumulation of dollar reserves has not proved particularly useful for the official sector either, difficult as it is for them to monetize their holdings at a time of crisis without leading to a potential crash in the treasury market.

The natural conclusion to draw is that central banks need to become less reliant on the dollar. The statements from the Russian and Chinese governments proposing that the US dollar should be replaced eventually by a global single currency, such as the IMF’s Special Drawing Right, suggest that central banks are thinking along similar lines. The Chinese, especially, as the biggest holders of US financial assets, are becoming worried about the inflationary implications of the Federal Reserve’s decision to print money. The Chinese are not about to dump dollars but the message from its central bank governor was a clear warning that it might start reducing its dollar holdings.

The idea of a single global currency is not new. John Maynard Keynes proposed the notion during the Bretton Woods conference in 1944. Since then, whenever a financial crisis has arisen there have been calls to replace the dollar as the global reserve currency. The trouble is that there is no credible alternative. No other national currency is viable. As for the SDR, a currency basket comprising dollars, euros, yen and sterling, there are far too many drawbacks, including issues of liquidity, allocation and supervision. Certainly, the IMF is in no position to become a pseudo-central bank. It has enough problems to grapple with – and enough credibility issues.

Perhaps the answer is reserve currency diversification, as the Russians have suggested too, including emerging market currencies. Mandeng believes the Russians have a point and argues that the framework to make this system work could be put in place by the G20, which comprises the main issuers and holders of international currencies.

Again, though, there is an issue of credibility. The outlook for the euro and sterling is bleak while currencies such as the renminbi, rouble and rupee will always have shortcomings until the Chinese, Russian and Indian economies become established financial powers. In any case the renminbi and rupee are not fully convertible, while Russia does not yet use a real time gross settlement system.

Until these considerable obstacles are overcome it appears the dollar will continue as the global reserve currency even if there is little appetite among central bankers for it to remain so. It is yet another paradox of the financial crisis.