July 6, 2009
The call to find an alternative to the U.S dollar as the global reserve currency is gaining momentum as France joined calls by China, India and Russia for a review of the world's currency practices.
French Finance Minister Christine Lagarde challenged the dollar's supremacy “in a world that has changed because of the crisis and the growing role of emerging countries.”
The questioning of the U.S. dollar as the key currency for central banks by a leader of a major European economy gives renewed life to the issue at this week's Group of Eight summit meeting in L'Aquila, Italy. The U.S. dollar has long served as the dominant medium of exchange, and tends to dominate the official money reserves that countries hold through their governments and at their central banks.
In the first quarter of 2009, 65 per cent of the world's allocated foreign exchange holdings were held in U.S. dollars, according to the International Monetary Fund. That's the highest in seven quarters.
The push for an alternative is being driven in large part by concern over the weakened state of the U.S. economy.
The country is forecasting fiscal deficits for the next decade.
That's leading large holders of U.S. debt such as China to worry that the U.S. dollar may not be as safe as it once was. In addition, the dollar has been volatile on international currency markets, and the U.S. is running ongoing trade deficits.
Diversification would likely take years, because unwinding large reserve positions of U.S. dollars too quickly would devalue them. And despite concerns about the greenback, it has maintained its international appeal, in part because investors need the value of their U.S. dollar holdings to stay high.
With the U.S. continuing to require willing lenders to fund deficits, the situation has become what top Barack Obama economic adviser Lawrence Summers once dubbed “a kind of balance of financial terror.”
That U.S. Treasury bills appreciated in the immediate wake of the financial crisis was proof of the dollar's strength, as “people fled to a stable place,” said Paul Wachtel, a professor at New York University.
Still, the risk of a move away from the greenback is not without precedent, said Shaun Osborne, chief currency strategist of TD Securities. “The U.S. is a bit complacent about this. Most U.S. officials appear confident there will be no quick switch away from the dollar. But we have seen before, with the decline of the pound, that these things can happen quickly, in the space of years.”
Recent comments may be as much about politics as economics.
Large developing countries are seeking a greater role at the International Monetary Fund. China controls only 3.66 per cent of the votes at the body, despite being the world's third-largest economy.
“A little bit of nationalism, a little bit of searching for someone to blame for the economic crisis,” Prof. Wachtel said. “Plus, it's a changing world: diversification of reserves might make sense.”
Canada and Japan both reaffirmed their support for the greenback this week.
“It's an issue that we have not addressed, other than to say that in the midst of what is still a significant global recession, it's important that we aim for stability,” Finance Minister Jim Flaherty said on Friday. “The stability has been based on the U.S. dollar as the global currency.”
Whether and how this will actually come up at the G8 summit remains unclear. Russia is a G8 member, and China and India are set to join the discussions on the second day of the three-day meeting, but all are playing down the prospect of formal talks just yet.
Chinese Vice-Foreign Minister He Yafei said yesterday: “You may have heard comments, opinions from academic circles about the idea of establishing a super sovereign currency. This is all, I believe, now a discussion among academics. It is not the position of the Chinese government.”
The Chinese central bank, the world's largest external holder of U.S. debt, reiterated its call for a new international reserve currency in a policy review published last week. It has proposed an International Monetary Fund-created unit called Special Drawing Rights as an alternative reserve currency.
Regardless of what happens at the G8 summit, some analysts expect a diversification in large countries' currency practices.
Alternatives like the euro, yen, Chinese yuan, and Special Drawing Rights all have drawbacks, said Benjamin Cohen of the University of California-Santa Barbara. “A more fragmented currency system seems in the offing, with much competition and no money clearly dominant,” Prof. Cohen said.
With files from Bloomberg News and Reuters