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. Read the rest of this entry »