New Reserve Currency Idea is Doomed

In recent days, various finance ministries from Moscow to Beijing have suggested a new reserve currency to replace the US dollar. The idea has great merit, and it would be in the global interest to create such a unit of account. At the same time, replacing the dollar would create so many losers that the political drive behind such a move is almost certain to fail. The US doesn't want it, the Chinese don't (despite what they say), nor do the Arabs, the Japanese or the other holders of US debt instruments. So, whatever the economic sense it might make, the political reality is that the dollar will remain the reserve currency of the global economy for the indefinite future.

When the world went off the gold standard, it lost a universal unit of account – an ounce of gold. However, the problem with the gold standard was the relatively fixed amount of gold in the world relative to the growing economies of North America and Europe. Indeed, one of the great forgotten political issues of the 1890s was bimetallism, backing US currency with silver at a set ratio to gold to increase the money supply. The Yukon gold rush rendered bimetallism irrelevant, but the problem was clearly there.

In the post-World War II system, the International Monetary Fund established “Special Drawing Rights” as a new unit of account in 1969 to overcome the fixed quantity of gold. SDRs are a fictional currency (there's no such thing as a 10 SDR note) created out of a basket of currencies weighted according to their importance in world trade. Basically, that means the US dollar, the euro, the Japanese yen and the pound sterling. When a country gets into trouble financially, it can go to the IMF and get a loan valued in SDRs but usually paid out in dollars.

If a new and improved SDR were created, its use would cost a great many global powerhouses money. The US would be the biggest loser. Because the entire world operates on the dollar for international trade, the US gets to borrow cheaply and consume more than it could otherwise afford. China would also lose out. Holding a trillion plus in US currency and $740 billion in US debt, the adoption of an enhanced SDR would reduce demand for the US dollar, and therefore, reduce its value. A 5% drop in the value of the dollar, which some economists believe is the premium for the buck being the reserve currency, would cost China $80 billion or so. America's other creditors would be harmed in much the same way.

While it is true that the SDR as it stands now ignores the yuan, ruble and rupee, the case for replacing the dollar just isn't there. If nations other than the US truly wanted to topple the dollar from its pedestal, they could do so simply by using other currencies for international transactions. Instead, they pay for oil, cars and wheat with the buck voluntarily. It's Gresham's Law in reverse with good money driving out bad. The US dollar is preferable to a Zimbabwean dollar and everyone knows it.

© Copyright 2009 by The Kensington Review, Jeff Myhre, PhD, Editor. No part of this publication may be reproduced without written consent. Produced using Fedora Linux.

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