A cornerstone of America’s international economic might is the dollar’s status as the international reserve currency. Simply put, the dollar is the device that parties use for international transactions — even those that do not include the United States. The readiness to use the dollar reflects the parties’ faith and confidence in the stability of that currency. They believe its value is predictable; thus there is more certainty in the exchange.
The country whose currency is held in reserve enjoys immense economic advantages. It does not have to worry about exchange-rate fluctuations having a direct effect on the trade of goods priced in that currency. Americans can be certain of the price of a barrel of oil priced in dollars; Japanese (or any other purchaser who does not use dollars) are not. They must accept the costs in dollars and then calculate the price in their own currency, and that exchange rate changes daily.
Alternatively, those other countries can purchase and hold dollars, effectively lending the U.S. their savings. Today, about two-thirds of global central bank foreign exchange reserves are held as dollars. This lowers interest rates in the U.S., providing a real economic advantage for the U.S. If the currency is stable or expected to be stable, such lending makes sense. If a devaluation looms on the horizon, it does not.
Thus the recent call by Mr. Zhou Xiaochuan, the governor of the People’s Bank of China, to establish a new international reserve currency, was a shot across the bow of the U.S. In an essay published on the bank’s Web site, Mr. Zhou recommended creating an expanded reserve currency whose value is based on a basket of major currencies (including the euro, yen, pound and dollar) and which is controlled by the International Monetary Fund. His proposal endorsed the use of “special drawing rights” — now a neutral measure of an IMF member nation’s reserve assets in the international monetary system — as a “super- sovereign reserve currency” that would be disconnected from any nation. This would insulate trade from changes in the value of the dollar and, ideally, better stabilize international exchange.
Such a move would also, not coincidentally, strike a body blow to America’s economic standing. In the crudest terms, it would constitute a vote of no-confidence in the U.S. While that thought may lurk deep in the mind of Mr. Zhou, he is not seeking to replace the dollar. China is the largest holder of U.S. debt, possessing $1.45 trillion in U.S. securities at the end of 2008 (out of a total $1.9 trillion in Chinese foreign reserves). Policymakers in Beijing are worried that President Barack Obama’s massive stimulus plans will create inflation in the U.S., which would devalue the U.S. dollar relative to the Chinese renminbi and thus erode the value of the foreign reserves.
Chinese Prime Minister Wen Jiabao signaled his unease in a press conference earlier this month when he called for U.S. efforts to “maintain its good credit, to honor its promises, and to guarantee the safety of China’s assets.” Reminding U.S. policymakers of China’s interest in stability makes sense. Pressing for a change in reserve currencies — which would hasten the fall in the dollar’s value and in turn hurt China — does not.
The Chinese statements reflect unease with the structure of the international order. Despite the fact that it is the world’s third-largest economy and has huge foreign exchange holdings, Beijing’s voice within international economic institutions, such as the IMF, is muted. It has just 3.7 percent of the voting rights at the IMF; in contrast to the 17 percent held by the U.S. and 6 percent by Japan (the second-largest bloc). China is not a member of the Group of Seven or Group of Eight, the club of “rich nations” that is presumed to govern the global economy.
Chinese leaders such as Mr. Zhou and Mr. Wen are making clear their desire to have a greater say in global economic decision-making. Beijing is sending a clear signal to the G20, scheduled to meet in London this week.
China’s leaders are also demanding greater U.S. sensitivity to Chinese concerns in the bilateral relationship. Talk of a G-2, sometimes called “Chimerica,” that would “guide” global thinking both flatters and unnerves China’s elite. While demonstrating the respect China’s leaders feel they deserve, such talk also demands greater responsibility for providing international public goods. Beijing prefers to focus on its own priorities and needs.
When asked about Mr. Zhou’s remarks, U.S. Treasury Secretary Timothy Geithner said he had not read the proposal but that the U.S. was “actually quite open to it.” Within 10 minutes, the dollar fell 1.3 percent against the euro. Offered the chance to clarify his comment, he explained that he only meant that expanding the role of special drawing rights made sense and that the “dollar remains the world’s dominant reserve currency.” He added that the U.S. would do “what’s necessary to make sure we’re sustaining confidence in our financial markets.” That is good for the U.S. and good for the world.
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