Zhou Xiaochuan, the People’s Bank of China’s governor, suggests this:
“When a national currency is used in pricing primary commodities, trade settlements and is adopted as a reserve currency globally, efforts of the monetary authority issuing such a currency to address its economic imbalances by adjusting exchange rate would be made in vain, as its currency serves as a benchmark for many other currencies. While benefiting from a widely accepted reserve currency, the globalization also suffers from the flaws of such a system. The frequency and increasing intensity of financial crises following the collapse of the Bretton Woods system suggests the costs of such a system to the world may have exceeded its benefits.“
For these reasons, he wouldn’t advocate any other currency replacing the US-Dollar. Obviously, his proposal also reflects Beijing’s worries that its US-Dollar reserves will continue to melt down in value, and it probably counts as a chip at the negotiation table. Zhou advocates the International Monetary Funds’ (IMF) special drawing rights as an alternative means of payment. A China Daily article estimates that 70 percent of China’s $ 1.95 trillion foreign exchange reserves are in US-Dollars. China Daily also quotes Erh-Cheng Hwa, chief economist of the Bank of Communications [or China Construction Bank, see second para from here]:
“Despite all the talk of ‘confidence’, investors are still deeply concerned about their holdings of the US dollar and Treasuries, not only in China, but around the world (…..) Zhou’s proposal, along with others’, could add more pressure on the US government to take real responsibility to clear up the mess it has created.“
For the time being, the U.S. would probably veto any replacement of the US-Dollar.
“Why should the U.S. give up its reserve currency position, which enables it to borrow easily?” said Hua Ercheng [see above, there, he is referred to as the Bank of Communication‘s chief economist] , chief economist in Beijing at state-owned China Construction Bank Corp., adding that the U.S. government has veto power in the IMF. “They won’t allow any other currency to compete for the dollar’s dominant position,“ according to Wang Tao, head of China research at UBS AG.
That’s probably true for the time being, but not necessarily in the long term. Joseph Stiglitz urged a global reserve system in a speech in Shanghai last week.
And in a guest contribution to the Wall Street Journal China Blog today, Arvind Subramanian, in a direct reference to governor Zhou’s costs-and-benefits comparison points out that both the U.S. and China had accepted mutual trade as is, and that China shouldn’t portray itself as a victim of the global financial crisis:
“China’s development strategy has been simple and focused: export at all and any costs. To achieve this, China has maintained an undervalued exchange rate. This mercantilist strategy has empirical backing. Recent academic research (for example, by Harvard’s Dani Rodrik) supports the view that undervalued exchange rates can provide a means of escape from under-development and an engine of long run growth. So, China’s development strategy has been sensible. (…..)
For China, let us for the sake of argument assume (conservatively) that mercantilism led to a higher annual productivity growth rate of 1 percent for a period of 10 years (this is consistent with the estimates in the papers by Rodrik and others). This extra productivity growth results, after ten years, in a level of GDP that is higher by 10 percent than it would have been otherwise. One year of this GDP gain is lost in the depreciation of the reserves. But this higher GDP is a permanent benefit that occurs every year and extends well beyond the ten year period. Precise quantification of the net benefits depends on many assumptions but the broad orders of magnitude are clear: the total GDP boost from mercantilism is substantially greater than the financial costs.“
In the longer run, a super-sovereign reserve currency seems to have good prospects. Every country (or other body, like the EU or Euroland for example) should think twice before advocating its own currency which would only make it harder for their central banks to live up to their own economies’ requirements. A super-sovereign currency makes sense. But until alternatives to the current US-Dollar-based global economy become real, trade partners of all colors will need to make their picks among existing currencies as they see fit.