No Change for the Dollar

April 24, 2009 • Commentary
This article appeared in the Guardian on April 24, 2009.

The latest idea for supplanting the US dollar as the world’s reserve currency just doesn’t make sense

Many governments and economists are increasingly unhappy with the US dollar as the world’s main reserve currency. Momentum is building up for using the Special Drawing Rights (SDR) of the International Monetary Fund to supplement or rival the dollar as the main global reserve currency. The SDR, however, is more like an exchange‐​traded fund (ETF) than a currency, and is not a viable alternative to the dollar.

The IMF issues no SDR currency notes. This is because the SDR is simply a potential claim on the national currencies of IMF members. Those cashing in their SDR allotments for dollars or euros have to pay a low interest rate until they repurchase those allotments, so the SDR is effectively a low‐​interest line of credit. It is also a synthetic unit of account, a monetary basket with the following weights: US dollar 44%, euro 34%, yen and sterling 11% each.

To become a true currency, the SDR would have to be a fully convertible instrument, not a line of credit, underwritten by countries with “hard” currencies. Politically, this seems unfeasible save in modest quantities. Even if the political hurdles are overcome, the SDR will remain a basket of national currencies, not an independent currency. To this extent, it will resemble an exchange traded fund (ETF), whose value is that of a basket of equities, such as the Dow Jones industrial average, or the S&P 500. Such ETFs merely provide a simple way of investing in a basket of equities, and are not a rival form of equity. Similarly, the SDR can merely provide a convenient way of holding a basket of currencies, and will not be an alternative reserve currency.

The dollar is the world’s main reserve currency because the US economy is the biggest in the world, and the US government can tax its citizens to service its national debt. The IMF has no national income and no authority to tax its members. The IMF cannot issue any credible currency of its own, and can only offer a currency ETF.

China is especially unhappy with today’s US dollar dominance. Two‐​thirds of its $2 trillion of foreign exchange reserves is held in dollar securities. The Obama administration is running up record fiscal deficits, and this may eventually lead to a collapse of the dollar, and hence of the value of China’s reserves. So Zhou Xiaochung, China’s central bank governor, is seeking to increase the role of the SDR as a reserve currency, as an alternative to today’s dollar‐​dominated regime. Strong support has come from an UN committee headed by Nobel laureate Joseph Stiglitz, and from other eminent economists, including Fred Bergsten of the Peterson Institute of International Economics and Martin Wolf of the Financial Times.

These economists view the existing global reserve system as grossly inadequate and needing overhaul. True, but the SDR is not a viable alternative. Suppose China, in search of diversification, shifts $1tn of its reserves from dollars into SDRs (some economists want this to be done in an IMF substitution account). Given the currency weights in the SDR, this would be no different from China putting $440bn into dollars, $340bn into euros, and $110bn each into yen and sterling, something it can do without needing SDRs. So, the attempted diversification will simply rearrange the existing furniture.

SDR issues represent potential liabilities for the underwriting economies — the US, EU, Britain and Japan — which are therefore wary about new issues. Western legislators have in the past criticized SDRs as inflationary. This explains why only $32bn of SDRs have been issued since 1971. The G20 agreement on another $250bn‐​worth has been made possible by the global meltdown, which has put inflation on the back‐​burner. This mood cannot last. It will be politically and financially unfeasible for countries underwriting SDRs to issue enough to rival other hard currencies held in global foreign exchange reserves.

The current global meltdown owes much to macroeconomic imbalances. After the Asian financial crisis in 1997–98, many Asian countries, including China, decided to maintain large foreign exchange reserves to guard against a repeat disaster. But the mirror image of such huge Asian surpluses was huge deficits in the US and UK. These unsustainable imbalances have now ended in tears. So economists seek ways in which Asian countries’ desire for high reserves can be met without their having to pile up dollars. Large currency swaps could be a partial answer. But not the SDR.

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