Global Policy Agenda: Reserve Currencies
It would be an understatement to say the US Dollar (USD) has come under attack over the past few months. There has been much debate among developed and developing countries concerning the USD role as a global reserve currency. As a result of our administration’s attempts to impede the ongoing recession, foreign investors have been expressing their fears about the future value and stability of our nation’s currency. Increased deficit spending has dramatically increased the federal deficit over the 2009 fiscal year from $459 billion to $1.580 trillion, or 11.2% of GDP (Knoller, 2009). Such large deficits can destroy economies, but one of the main concerns with the U.S. is inflation. Generally, deficits lead to increased government borrowing, which eventually leads to rising inflationary conditions resulting in the depreciation of a country’s currency. One of the leading voices addressing their concerns over the USD is China, who is our government’s largest foreign creditor – holding an estimated $800 billion in U.S. Treasuries. Although current data shows little change in foreign reserve holdings of USDs, China, along with numerous other countries have voiced alternative initiatives regarding a major shift in a global reserve currency. The objective of this paper will be to detail those alternative theories while depicting the possible future of our international financial system.
The World Bank’s Zoellick states “the dollar’s fortune will depend on how well the U.S. can bring down its debt load without stoking inflation while restoring a healthy financial system and private sector” (Barkley, 2009).
Another supported alternative to the USD involves a shift to a different reserve currency, which has been cited as either the Euro or the Chinese Renminbi. In the case of the Euro, the currency has been raising its share of total international reserves over the past decade. Currently, the Euro accumulates 25% of all reported international reserves holdings (Moghadam, 2009). Zoellick (2009) differentiates the Euro versus the Renminbi according to their estimated timelines. The Euro may be a respectable short to medium term alternative to the USD, where the Renminbi is a long-term alternative. If the Chinese were to bring the Renminbi into competition with the USD as a reserve currency, one obvious step would include the government converting their currency regime from a managed-fixed exchange to a flexible-market exchange dictated by the open foreign exchange market. In recent years, the People’s Bank of China has protected its Yuan from appreciating in order to facilitate the country’s export led growth; such a loss of control may not be allowed for years to come. Most importantly, merely replacing one dominant currency with another would do little, if anything, to alleviate the concerns that have been expressed about the current system.
A third alternative to the USD is the IMF’s Special Drawing Rights (SDR), which is different from a typical currency. It takes its value from its constituent currencies (USD, Euro, Pound Sterling and Yen), which makes SDRs diversified and more stable. If one of its constituent currencies depreciates, the share of the other in the basket rises proportionally, dampening the volatility of the basket (IMF). Interestingly, SDRs were created 1969, a few years before the collapse of the original Bretton Woods system. The relevance of SDRs quickly faded shortly after, but recently much attention has been given to these “potential claims on the freely usable currencies of IMF members” (Special, 2009). As of September 3rd, China signed an agreement to buy $50 billion in notes denominated in SDR’s while Russia and Brazil are both predicted to each buy $10 billion in notes. In order “for the SDR to take on such a significant role (as a reserve currency), its liquidity would need to increase massively” (Flint, 2009). With about 4% of global reserves, generating a liquid SDR market would be a major undertaking. Global agreement similar to the scope of the Bretton Woods system will take much cooperation, and with the majority of the BRIC nations supporting the SDR market, serious reform of the international financial system could be already underway.
References
(2009, August 27). Special Drawing Rights. Retrieved from http://www.imf.org/external/np/exr/facts/sdr.htm
Barkley, T. (2009, September 30). Zoellick Sees ‘Other Options’ to Buck. Retrieved from http://online.wsj.com/article/SB125418301226347949.html
Flint, R. (2009, September 3). China Starts Journey to New Reserve Curren
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