On March 23 China's central bank governor, Zhou Xiaochuan, threw down the gauntlet in an essay posted on the Web site of the People's Bank of China challenging the global hegemony of the US dollar and proposing its gradual replacement with a super-sovereign currency, based on the International Monetary Fund's (IMF) Special Drawing Rights (SDR), created in 1969 and managed by the IMF. This currency would be "… disconnected from individual nations and … remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies." Without mentioning the US dollar explicitly the essay, titled "Reform the International Monetary System," indirectly blamed the dollar's hegemony for the current global financial crisis. The challenge re-emerged on March 26 in the report of a UN advisory committee of economists chaired by Nobel laureate Joseph Stiglitz.
The official US response was understandably negative in light of the huge economic and non-economic benefits the US has derived from the widespread use of its currency outside of the US since the end of World War II. But the overall reaction outside the US government was that the Chinese proposal, which mirrors the proposal made by John Maynard Keynes but rejected by the US at the founding of the IMF in 1945, merited discussion despite its flaws. The IMF, which would acquire a much greater role in the creation and management of the super-sovereign currency through a supercharged SDR, declared that the proposal should be taken seriously. But The Wall Street Journal attacked the proposal to dethrone the US dollar, although conceding that China's concerns about the stability of the US dollar were justified. After blaming the US government for excessively expansionary macroeconomic policies that flooded the world with dollars, it argued that "the dollar's status as a reserve currency gives the US enormous advantages, and it should be protected ferociously by our public officials."
The US dollar is the dominant global currency in terms of its role as: (1) a reserve currency in which countries other than the US hold about two-thirds of their foreign exchange reserves; (2) a vehicle currency in which most of international trade and financial transactions are denominated and settled; and (3) a medium of exchange and store of value for individuals and companies outside of the US which hold more than half of the US currency in circulation. These different but interrelated uses of the US dollar outside the US generate substantial economic benefits for the US in terms of seigniorage, which is the profit from money creation. When the US issues currency in dollar coins and banknotes, it receives real goods and services at a very small cost of issuing the currency. When the US borrows from the rest of the world in US dollars to finance its current account deficit, it benefits from very low interest rates and the privilege of servicing its external debt in US dollars.
This challenge to US dollar dominance is one of the consequences of the global financial crisis, which originated in the US, and of the controversial US policies to end that crisis. Although this challenge was initiated by Russia on March 16, not much attention was paid until China adopted it as its own. China, after all, is a much more important player than Russia in the global economy. It accounts for the world's third largest gross domestic product (GDP) at market exchange rates and the second largest at purchasing power exchange rates; it has the world's largest foreign exchange reserves; and, it is the largest creditor of the US. It is justifiably concerned that the expansionary US fiscal and monetary policies will eventually cause the US dollar, in which it holds more than half of its $2 trillion foreign exchange reserves, to depreciate sharply, leading to huge capital losses. That would be tantamount to partial default by the US on its external debt. This has a precedent in the repeated devaluations of the US dollar during the collapse of the Bretton-Woods fixed exchange rate system in 1971.
This is a challenge which might receive broader support from other emerging market economies, such as Brazil and India, that the US cannot ignore as to the privileged status of its currency as well as to its dominant leadership in the governance of the global economy. This challenge has put an emboldened China on the offensive and the US on the defensive in restructuring the global financial system. But it will not bear fruit in the short run, as acknowledged by China itself. The proposal, even if it does not achieve its professed objective of eventually deposing the US dollar as the ruling global currency, could serve China's national interest by putting pressure on the US and the EU to grant it a greater role in the governance of the IMF. I disagree with those who claim that the proposal is empty rhetoric not worth discussing as well as with those who view it prematurely as a metaphor for the decline and the imminent fall of the US as the economic and political superpower. The proposal is a timely warning to the US.
We know that the rise, reign and fall of national currencies, such as the British pound sterling and the US dollar, as global currencies occur over several decades, reflecting long-term shifts in global economic, political and military power. Trying to turn the SDR, a weighted currency basket currently consisting of the US dollar, the euro, the yen and the pound sterling, into a global currency by an international agreement has been aptly compared to the failed attempt to establish Esperanto as the dominant world language. The continued US dollar dominance after the collapse of the Bretton-Woods system was supported paradoxically and disingenuously by China itself in its symbiosis with the US As it ran current account surpluses, generated by its 30-year-old mercantilist export-driven development strategy based on an undervalued exchange rate, it accumulated massive US dollar assets, becoming the major creditor of the US, the world's largest debtor nation. China can free itself from its now uncomfortable dependence on the US dollar by reducing its current surpluses, i.e., by saving less and consuming more at home.
It can also gradually diversify its foreign exchange reserves by holding more of other major fully convertible currencies. The Chinese renminbi's prospects for becoming a global currency to rival the US dollar cannot be discussed credibly until China allows its currency to become fully convertible. I do not see that happening in the foreseeable future as the Chinese communist regime is loath to surrender its tight control over the economy.
