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Weaning the world from US dollar reserves and increasing SDRs
By Onno de Beaufort Wijnholds |
May 12, 2009, Tuesday
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ZHOU Xiaochuan, the governor of the People's Bank of China, recently suggested that replacing the dollar with the International Monetary Fund's Special Drawing Rights as the dominant reserve currency would bring greater stability to the global financial system.
The idea of reforming the system by introducing a supranational reserve currency is also, it appears, supported by Russia and other emerging markets. And a United Nations advisory committee chaired by the Nobel laureate Joseph Stiglitz has argued for a new global reserve currency, possibly one based on the SDR.
Transforming the dollar standard into an SDR-based system would be a major break with 60 years of policy. The SDR was introduced 40 years ago to supplement an inadequate level of global reserves, and was enshrined in the IMF's amended Articles of Agreement as the future principal reserve.
But the world soon became awash in dollars. So, instead of becoming the principal reserve asset of the global system, the proportion of SDRs in global reserves shrank to a tiny fraction, rendering the SDR the monetary equivalent of Esperanto.
Although the euro, created in 1999, turned out to be a more serious competitor to the dollar, its share in total international reserves has probably remained below 30 percent, compared to 65 percent for the dollar (these shares are in part estimates, as some countries do not report the currency composition of their holdings).
There are two ways to reduce the dollar's role in the international monetary system. One possibility is a gradual, market-determined erosion of the dollar as a reserve currency in favor of the euro. But, while the euro's international role has increased since its inception, it is hardly expected to overtake the dollar as the dominant reserve currency in the foreseeable future.
This outcome is probably only possible if two conditions are met: first, the United Kingdom joins the euro area, and, second, the United States makes serious, confidence-sapping mistakes. Mistakes already have been made but now US policies should help avoid a major dollar slide.
With the dollar's hegemony unlikely to be seriously undermined by market forces in the short- and medium-term, the only way to reduce the major dollar's role as a reserve currency is by international agreement. The Chinese proposal falls into this category.
One way to make SDR the major reserve currency relatively soon would be to create and allocate a massive amount of new SDRs to the IMF's members. While G20 leaders support an SDR allocation of US$250 billion, this only increase SDRs to around 4 percent of total international reserves.
Close to US$3 trillion in SDRs would need to be created to make it a viable global reserve currency. Clearly that's unrealistic.
Alternative
But there is a more realistic way. Back in 1980, the IMF almost adopted a so-called SDR Substitution Account. It would permit countries whose official dollar holdings were larger than they were comfortable with to convert dollars into SDRs.
Conversion would occur outside the market, and thus would not put downward pressure on the dollar. Member countries would receive an asset that was more stable than the dollar, as it was based on a basket of currencies, thereby providing better protection against losses.
The plan fell apart when some IMF shareholders rejected the burden-sharing arrangements necessary in case of losses due to exchange rates. The US lost interest as the dollar strengthened.
Today, however, the changed international climate, and the possibility of a bout of severe dollar weakness, could convince the US to accept a conversion scheme.
Even if an SDR Substitution Account is established, the dollar's role in global reserves is unlikely to drop significantly.
But one can envisage a system in which international reserves are held each in roughly equal shares of dollars, euros and SDRs.
(Onno de Beaufort Wijnholds is a former executive director of the International Monetary Fund and a former permanent representative of the European Central Bank in the US. Copyright: Project Syndicate, 2009. www.project-syndicate.org)
The idea of reforming the system by introducing a supranational reserve currency is also, it appears, supported by Russia and other emerging markets. And a United Nations advisory committee chaired by the Nobel laureate Joseph Stiglitz has argued for a new global reserve currency, possibly one based on the SDR.
Transforming the dollar standard into an SDR-based system would be a major break with 60 years of policy. The SDR was introduced 40 years ago to supplement an inadequate level of global reserves, and was enshrined in the IMF's amended Articles of Agreement as the future principal reserve.
But the world soon became awash in dollars. So, instead of becoming the principal reserve asset of the global system, the proportion of SDRs in global reserves shrank to a tiny fraction, rendering the SDR the monetary equivalent of Esperanto.
Although the euro, created in 1999, turned out to be a more serious competitor to the dollar, its share in total international reserves has probably remained below 30 percent, compared to 65 percent for the dollar (these shares are in part estimates, as some countries do not report the currency composition of their holdings).
There are two ways to reduce the dollar's role in the international monetary system. One possibility is a gradual, market-determined erosion of the dollar as a reserve currency in favor of the euro. But, while the euro's international role has increased since its inception, it is hardly expected to overtake the dollar as the dominant reserve currency in the foreseeable future.
This outcome is probably only possible if two conditions are met: first, the United Kingdom joins the euro area, and, second, the United States makes serious, confidence-sapping mistakes. Mistakes already have been made but now US policies should help avoid a major dollar slide.
With the dollar's hegemony unlikely to be seriously undermined by market forces in the short- and medium-term, the only way to reduce the major dollar's role as a reserve currency is by international agreement. The Chinese proposal falls into this category.
One way to make SDR the major reserve currency relatively soon would be to create and allocate a massive amount of new SDRs to the IMF's members. While G20 leaders support an SDR allocation of US$250 billion, this only increase SDRs to around 4 percent of total international reserves.
Close to US$3 trillion in SDRs would need to be created to make it a viable global reserve currency. Clearly that's unrealistic.
Alternative
But there is a more realistic way. Back in 1980, the IMF almost adopted a so-called SDR Substitution Account. It would permit countries whose official dollar holdings were larger than they were comfortable with to convert dollars into SDRs.
Conversion would occur outside the market, and thus would not put downward pressure on the dollar. Member countries would receive an asset that was more stable than the dollar, as it was based on a basket of currencies, thereby providing better protection against losses.
The plan fell apart when some IMF shareholders rejected the burden-sharing arrangements necessary in case of losses due to exchange rates. The US lost interest as the dollar strengthened.
Today, however, the changed international climate, and the possibility of a bout of severe dollar weakness, could convince the US to accept a conversion scheme.
Even if an SDR Substitution Account is established, the dollar's role in global reserves is unlikely to drop significantly.
But one can envisage a system in which international reserves are held each in roughly equal shares of dollars, euros and SDRs.
(Onno de Beaufort Wijnholds is a former executive director of the International Monetary Fund and a former permanent representative of the European Central Bank in the US. Copyright: Project Syndicate, 2009. www.project-syndicate.org)
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