>ASIAN CURRENCY RESEARCH (DBS)

Reserve currency debate – more than meets the eye

In March 2009, China triggered a debate by recommending to reform the international monetary system with a new super reserve currency. Many viewed this as a challenge to the USD’s role as the world’s dominant reserve currency. Since then, confidence in the greenback has been persistently dogged by fears that central banks might diversify their foreign reserves away from dollars.

To shed more light on the subject, we examined the history and evolution of the international monetary system. While we make no bold claims as to the outcome of this debate, we hope to shed some light on what we consider to be the more important issues in this debate.

We believe that the debate goes beyond the fireworks pressurizing the USD and its reserve currency status. To us, these calls are symptoms to a larger and more pressing problem that manifest itself most as a shortage in global trade finance. With the American consumer saving and not spending, the US is no longer able to maintain its long-held role of supply dollars for the expansion of the global economy and world trade without imperilling its fiscal position.

Suffice to say, this is not the first time the dollar’s status has been questioned and neither is it likely to be the last. Talks about adding the CNY to the IMF’s Special Drawing Rights (SDR) basket of currencies is not a new development. Ironically, the last time the SDR was expanded was in 1971 when Bretton Woods ended. Except that today we not talking about ending, but about the need for some form of new Bretton Woods system after the global financial crisis in 2008.

Nonetheless, the objective of expanding the SDR was the same then and now. The goal was to get other countries to help the US in its role to supply currencies to support world economic and trade activities. We see this as part of an evolutionary process where the post-WW2 world economy shifts its dependence solely on the US economy to other G7 nations. And today, the growth driver of the world economy has and is continuing to move away from the G7 nations towards the G20 economies. The lesson learnt in the 1970s was that while other currencies came to play a bigger role in the internationalization of the SDR, the dollar continued to dominate
the scene.

Apart from expanding the SDR, there is the other issue about creating and promoting the use of a new super reserve currency for payments in trade and investments. To us, this goes beyond the call to abandon the USD as the world’s chief reserve currency. Implicitly, and more importantly, this call to reform the international financial system may also be a proposition to abandon the flexible exchange rate regime that exists today. The common goal of Bretton Woods in 1944 and the search for a new Bretton Woods today is to rebuild the world economy via stability in exchange rates and commodity prices so that businesses can plan and implement investments. The use of a single currency by most countries as payments will be difficult to achieve without returning to a fixed exchange rate regime.

And before the world rushes to believe that the SDR will replace the USD, it must answer one simple question. Just as the US had to convince the post-war world that the USD would be “as good as gold” at Bretton Woods in 1944, China must first convince the world that the SDR will be “as good as dollars”.

To see full report: ASIAN CURRENCY RESEARCH