Recently Asian Development Bank (ADB) suggested, China’s yuan could rapidly become an internationally used currency and serve as an alternative to the U.S. dollar in central bank reserves. There weren’t many takers for ADB’s suggestion. I beg to differ from ADB’s stance. If China’s yuan becomes a reserve currency then, I ask, is there a guaranty that we won’t see another global financial crisis of the present order? In the wildest of possible pollyannaism, even ADB wouldn’t say that replacement of one reserve currency (US Dollar) with another (China’s yuan) would guarantee us a world free of a future global financial crisis of the present order. At best, I guess, that would be a temporary solution.
I think it is high time we ask the fundamental question – do we need a global reserve currency? Yes of course, there are significant economic incentives in agreeing to have a global reserve currency. But, hasn’t the concept of international reserve currency outlived its usefulness? I, for one, definitely believe so.
A decade ago, in the wake of the Asian financial crisis, Malaysia’s former Prime Minister, Dr Mahathir Mohammed, called on the world to ban currency trading and outlaw hedge funds, which he blamed for spectacular declines in the value of the Malaysian ringgit. His comments focused on the fact that currency trading served no tangible economic purpose and that hedge funds were opaque beasts wielding billions of dollars in vested interests. Though, I don’t agree with his thoughts in toto, I must say his thoughts did inspire me to ask the fundamental question – do we need a global reserve currency? Whatever, one’s answer to the above question may be, there is a broad consensus in the world that the global central banks are risking too much by holding much of their reserves in dollars. The consensus is so strong; there have been a rush of proposals such as – replacing greenback with a new reserve currency system based on the IMF’s special drawing rights; or a more coordinated approach to exchange rate policy involving target zones etc. There are plusses and minuses in all those proposals. But scrapping a global trade based on the concept of international reserve currency seems to be a better idea than all those proposals.
Since when did we have a global reserve currency? Going back from present to past – US Dollar, UK pound, French franc and Dutch guilder have been tacit global reserve currencies at some point since 1700. The acceptance, tacit or explicit, of a currency as international reserve has had been definitely correlated with the originating country’s military, economic and political strength. By that logic, China’s yuan is next in line to take the place of US Dollar. However, the same logic does lead us to believe that at some point in future China could abuse its yuan’s reserve currency status plunging the global financial system into may be even greater chaos.
Trading is as old as human race. Global commerce and trading has been in existence even before the concept of ‘generally accepted value for exchange’ came into existence. It is high time we should test the concept of ‘local reserve currency’. With the kind of technology both hardware and software that is available right now, I guess, it shouldn’t be difficult to test the concept of ‘local reserve currencies that dynamically point to an optimal reserve currency’.
Unlike in any point of history, national governments and the corresponding central banks are much savvier, technologically and conceptually. The western world that rankled at the rhetoric and slammed Mahathir for being reactionary and protectionist are now crying foul when sovereign wealth funds from Asia Pacific and other emerging markets are trying to get control over physical assets, governing bodies of business entities wherein they have invested. The central banks of emerging economic powers through their sovereign wealth funds and policy measures, I guess, are capable of wading through a global financial structure that is not forever fixed to the concept of ‘global reserve currency’. After all why should US try to perpetuate greenback as global currency when a study by McKinsey Global Institute (MGI) pointed out that the net financial benefit to the U.S. from greenback’s reserve currency status was between about $40 billion and $70 billion—or 0.3% to 0.5% of U.S. gross domestic product in 2007, and 2008 respectively. According to MGI estimate benefit from greenback’s reserve currency status declined to $25 billion in the year to June 2009. At this rate, it shouldn’t take more than five to 10 years for the US to see costs of maintaining greenback as reserve currency exceeding the benefits accrued from the same.
A call to replace greenback as reserve currency, if it comes from the US policy makers and politicians would have much weight in the international community than if the call came from some other nation. I guess, in their self interest the US policy makers and think tank should call end for greenback’s reign as global reserve currency.
Source: www.istockanalyst.com.
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