Should a super-sovereign Currency replace the US-Dollar?

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.

6 Comments to “Should a super-sovereign Currency replace the US-Dollar?”

  1. Just a few questions: Why did China keep US dollar as reserve ? Why not RMB, or Russian rouble, or Cuban peso ?

    What can US do if China stop using US dollars and use Russian rouble as reserve ?

    What can US do if China insist that people pay China in RMB when buying from China and gets RMB when selling to China, and all contracts, agreements and price quotations are all in RMB ?

    Come to think of it, why not gold. China is a great producer of gold, and will dominate the world economy if China insist on being paid in gold.

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  2. One more question: can I check my nugget account online?

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  3. In my opion, firstly China will not stop using US dollars as its reserves during a certain time in the future. Because US dollars is much stronger than any others,such as RMB, Russian rouble, or Cuban peso. The most important thing is that US dollars are accepted with strong confidence from most of the countries in the world, even facing the recession. In this case, if China just accept RMB only, then it will be inable to buy goods, technology and others from other countries which only accept US dollars within international trades. So I think a super-sovereign currency will not replace US dollars .

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  4. I wouldn’t expect the US dollar be replaced within ten years either – neither by another existing currency, nor by a super-sovereign currency. In the short run, the American government wouldn’t be interested in that anyway, because they still rely on deficit spending.
    But in the longer run, that will change. Even in the short run, the dollar will weaken further – and trade surplus countries like China, which naturally hold most of their currency reserves in dollars, won’t like the devaluation of their reserves.
    And for America (or any other country or union whose currency might replace the dollar), issuing the main reserve currency is also a mixed blessing. Yes, it allows you to run a much higher budget deficit – but it also requires you to keep your currency stable. Devaluations would help to make America’s industries more competitive on global markets.
    I believe that a super-national currency would be in everyones interest – but then, I’m no expert.

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  5. Suppose you are from China. Would you be in favor of there being more diversity in currency reserves instead of depending on the US dollar? Why? What are the pros and cons? If yes what other currencies would be appropriate for the roll?

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  6. I explained some of my (amateur, to be sure) views in the post and in my reply to Ivy’s comment above. Basically, in terms of employment and innovation, I believe that America must maintain an industrial base of its own – if the USD remained the main reserve currency, that would hamper America’s own development. But of course, the switch to a more diverse reserve currency system shouldn’t come overnight – that would crush the Dollar’s value.
    For the same reason, as not to devalue the USD reserves they have, export-led economies like China shouldn’t try to dispose of most of their USDs all of a sudden. It should be a careful, concerted process which (as far as I can see) will require close cooperation of all parties involved.

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