Dollar’s Days as the World’s Reserve Currency Are Far From Over

Graham — Wed, 11 Nov 2009 23:45:42 +0000

Worries about the dollar’s dominance of the global monetary system are not new. But debate about replacing the beleaguered dollar, whose trade-weighted value has dropped by 11.5% since its peak in March 2009, has resurfaced in the wake of a global financial and economic crisis that began in America. China and Russia, which have huge reserves that are mainly dollar denominated, have talked about shifting away from the greenback. India changed the composition of its reserves by buying 200 tonnes of gold from the IMF.

None of this threatens the dominance of the dollar yet, particularly as a dramatic shift out of the currency would be damaging to the countries (such as China) that hold a huge amount of dollar-denominated assets. But a new paper by economists at the IMF, released on Wednesday November 11th, acknowledges that the global crisis has reignited the debate about anchoring the world’s monetary system on one country’s currency.

Some say that America’s role as the principal issuer of the global reserve currency gives it an unfair advantage. America has a unique ability to borrow from foreigners in its own currency, and wins when the dollar depreciates, since its assets are mainly in foreign currency and its liabilities in dollars. By one estimate America enjoyed a net capital gain of around $1 trillion from the gradual depreciation of the dollar in the years before the crisis.

In a sense the world is hostage to America’s ability to maintain the value of the dollar. But as the IMF points out, the currency’s primacy arises at least partly because China and other emerging countries have chosen to accumulate dollar reserves. The depth of America’s financial markets and the country’s open capital account have made the dollar attractive. So some of the advantage has been earned.

But large and persistent surpluses in countries like China mean continued demand for American assets, reducing the need for fiscal adjustment by either country. This, in turn, has contributed to the build-up of the macroeconomic imbalances that many blame for the financial crisis.

Read the full article here

Chatter about a new global currency is overblown

Graham — Tue, 01 Sep 2009 01:50:31 +0000

There has been a lot of talk recently of a global currency in the near future. Robert Pozen does not see this happening. He believes SDRs have less potential than suggested by China. They could not become a viable global currency in their present form. You can read the article from the FT below:

At the US-China summit this week, Chinese officials raised concerns that the surging US budget deficit could undermine the value of China’s huge dollar holdings. These same concerns motivated the governor of the People’s Bank of China to suggest replacing the US dollar as the world’s reserve currency with special drawing rights issued by the International Monetary Fund. To be specific, he proposed that central banks be allowed to swap their dollar reserves for SDRs held in a substitution account by the IMF. SDRs represent a basket of four currencies – comprising 44 per cent US dollars, 34 per cent euros, 11 per cent yen and 11 per cent pound sterling.

However, SDRs are not a realistic alternative to US dollars as the global reserve currency because there are too few of them in circulation. For the same reason, swaps of US dollars for SDRs would have limited utility.

The outstanding amount of SDRs is presently $33bn, although the IMF will soon issue two new tranches. The first was recently approved by the US Congress. It amended the IMF articles to authorise a special allocation of another $33bn in SDRs, in order to provide them to the fifth of IMF members who joined after 1981 – the last time SDRs were issued.

In the second case, the IMF’s executive board this month backed the general allocation of $250bn in SDRs to all its members. This general allocation must be approved before August 7 by an 85 per cent weighted vote of the IMF’s board of governors, of which the US Treasury secretary holds almost 17 per cent. For technical reasons, this general allocation of SDRs requires the US Treasury secretary only to “consult” with Congress for 90 days – which has already been done.

Nevertheless, even with these two new tranches of $33bn and $250bn, SDRs would still constitute less than 5 per cent of the world’s foreign currency reserves. By contrast, US dollar instruments comprised 64 per cent of reserves at the end of 2008.

Moreover, SDRs can be held only by central banks, which count them as foreign currency reserves; they cannot be used by individuals or companies in global trade. Thus, SDRs lack one of the key defining characteristics of money – serving as a medium of exchange – a major impediment to becoming a global currency.

A further expansion of SDRs to fund a substitution account at the IMF would be useful in modest amounts. This account could help resolve the dilemma facing China and other large holders of US dollar reserves. These countries would like to reduce the risk that the US dollar will decline in value as the financial crisis subsides. On the other hand, these countries cannot sell large volumes of US dollars in the currency markets without precipitating the very decline in the dollar’s value that they want to avoid.

Presto! SDRs do the trick. A country can diversify a portion of its reserves by effectively swapping US dollars for the basket of four currencies represented by SDRs – without depressing the trading market for US dollars. For example, if Brazil swapped $10bn in US dollar instruments for the same amount of SDRs, it would reduce its exposure to the US dollar by $5.6bn – the portion of SDRs representing the euro, yen and pound.

But the IMF would then face two unattractive alternatives. It could sell the US dollars received in the swap and probably depress the trading market for them, or it could hold them and take the risk that the dollar would depreciate relative to the other currencies making up the SDR.

Given these two alternatives, the IMF may prefer to hold on to the dollars and take the risk of dollar depreciation. However, this could be done only if the amounts involved with the swaps were a relatively small portion of the SDRs in circulation. Otherwise the IMF could wind up with a dangerous mismatch – if its assets were comprised mainly of US dollars and its liabilities mainly of SDRs representing four currencies.

In short, SDRs have less potential than suggested by China. They could not become a viable global currency in their present form. Swaps with the IMF for SDRs would provide central banks with a convenient way to diversify their portfolios without depressing the market for US dollars. However, these swaps would have to be of limited volume because they effectively transfer the risk of dollar depreciation from central banks to the IMF.

Robert Pozen is the chair of MFS Investment Management and author of a forthcoming book on the financial crisis entitled ‘Too Big to Fail?’

Along The Margin » sdr

Dollar’s Days as the World’s Reserve Currency Are Far From Over

Chatter about a new global currency is overblown