Since the collapse of the Bretton Woods international monetary system, the dollar has been the anchor of global stability. However, 40 years down the road, time has come for the economic players to question the US dollar’s role as the world reserve currency. The US credit downgrade as well as the political debacle concerning the US debt ceiling have highlighted the international monetary system’s fragile foundations. Nowadays, a growing number of people believe that alternatives to the hegemony of the Greenback exist and should be taken into serious consideration.
The economist Robert Triffin pointed out in the 1960s that the reliance on a national currency as reserve currency for the world would inevitably lead to a conflict between international interests and the issuer’s domestic interests. Indeed, in order to satisfy the continuous foreign demand for the currency the issuer would have to run large trade deficits, which would in turn destabilise its economy. It seems like we have reached this stage today. As the world’s reserve currency, the dollar should be the strong base of the international monetary system. However, with its current account deficit surpassing $14,000bn, and the unfunded liabilities of Medicare and social security amounting to $100,000bn, further devaluation is inevitable. As Arvind Subramanian of the Washington-based Peterson Institute for International Economics puts it, “reserve currency status is not just about economic size and trade but about investors’ faith in policy credibility.” It is clear that the recent economic governance problems concerning the debt ceiling have deteriorated the US’ credibility. After all, currency value is based on trust, and in order to use the US dollar as a global reserve currency, the international community has to believe in the country’s capability of maintaining good governance and sound economic policies. The US is losing these key attributes.
Alternatives to the US dollar as a reserve currency are growing in importance. Since the financial crisis of 2008, gold has been pushed back in the spotlight, recognised as a safe haven while international currency markets are extremely volatile and imbalances persist. As a matter of fact, the European central banks have become net buyers of gold for the first time in two decades, according to the Financial Times. The central banks buying of gold greatly surpassed analysts’ expectations, especially following a long period during which they were dumping it. The most recent figures from the World Gold Council show that as a group, on a net basis, central banks bought about 208 tonnes of gold in the first half of this year alone. This is huge, only few analysts expected full-year net purchases of even 200 tonnes. Since the end of the Bretton-Woods system in 1971, the biggest annual net purchase of gold by central banks only amounted to 276 tonnes in 1981. These important purchases suggest that gold is once again in favour of investors around the world. Jonathan Spall, director of precious metal sales at Barclays Capital said in an interview: “We’re going back to a time when gold is seen very much as money”, “It has been a complete reversal of the attitudes we saw during the 1990s”. However, while gold certainly attracts a lot of attention in these volatile times, a return to something similar to the gold standard seems unlikely due to the lack of supply of gold. In addition, according to many economists, linking currencies and price levels to the value of a fixed or nearly fixed stock of precious metal forces real variables such as growth and employment to endure economic shocks.
On the other hand, in his much-discussed 2009 speech, Zhou Xiaochuan, China’s central bank governor, showed a keen interest in the IMF’s Special Drawing Rights (SDRs), which, according to him, could serve as a “super-sovereign reserve currency”. These SDRs are a sort of weighted basket of four currencies (the dollar, the sterling, the yen and the euro), whose value is determined by their floating exchange rates. The IMF would issue them and distribute them to various countries which could then use these SDRs in private transactions. Mr. Xiaochuan called on governments to issue SDR-denominated financial assets and promote SDRs in international trade and commodities pricing. Creating a separate substitution account could help spread the use of SDRs: countries could directly change their dollars for SDRs without interfering with the open currency markets. This would be very attractive for China or other countries willing to diversify from the dollar without causing a run on the currency, but the US opposes these measures to avoid the losses on the dollars that would be sold.
Some people view that another national currency could replace the dollar in the coming years as the main reserve currency. China holds up to date more than $3200bn in currency reserves and is therefore looking to diversify its investments. Xia Bin, a member of the monetary policy committee of the People’s Bank of China, said in a central bank publication in August that Beijing should urgently assess the risks of being the main investor in US debt and accelerate diversification of its reserves. Dariusz Kowalczyk, Hong Kong-based currency strategist at Crédit Agricole, said: “The overall sentiment in China may be shifting towards the following: it’s a lesser evil to accept faster currency gains – and therefore weaker exports and weaker growth of the economy – than to bear the risk of continued fast accumulation of Treasuries and European government debt.” In addition, Yu Yongding, a former member of the PBoC’s monetary policy committee, wrote in the Financial Times: “The People’s Bank of China must stop buying US dollars and allow the renminbi exchange rate to be decided by market forces as soon as possible. China should have done so a long time ago. There should be no more hesitating and dithering.” China’s faith in the West had deteriorated markedly in recent weeks and months. A shift in the country’s monetary policy could be a serious threat to the dollar as many of its Asian trading partners are actively promoting the use of the renminbi as a reserve currency. In fact, China has already taken steps to bolster the renminbi’s international status. For example, it hopes to allow all exporters and importers to settle their cross-border trades in the renminbi by the end of this year, as part of plans to grow the currency’s international role. The renminbi is expected by many economists to become the new global reserve currency in the coming years.
The last alternative would be creating a multi-polar reserve currency system. According to the Financial Times, “a recent survey of 80 central bank and sovereign wealth reserve managers by UBS found that more than half believed that a ‘portfolio of currencies’ would supplant the dollar as the most important reserve currency within 25 years”. In addition, Robert Zoellick, president of the World Bank, wrote that a new monetary system involving a basket of currencies “should also consider employing gold as an international reference point of market expectations about inflation, deflation and future currency values”. A similar option to using SDRs, this could be a good way to create a stable reserve currency.
Using a multi-polar reserve currency system or SDRs would be hard to coordinate, however. In order to work, these systems would need an international organisation to control its issuance globally. Looking at the euro debacle, this seems hard to imagine. According to Barry Eichengreen, economics professor at the University of California, Berkeley, and a leading expert on the subject, “no global government, which means no global central bank, means no global currency. Full stop.” There is no doubt that the dollar’s status of global reserve currency is threatened, however. “The US should be worrying more about whether its economic policies are a threat to the dollar now,” says Mr Dadush of the Carnegie Endowment, “than whether a threat to the dollar will derail its economic policies in the future.”