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Seeking a new global currency
The domination of the US dollar as the global currency has been under serious challenge in the past few weeks
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The domination of the US dollar as the global currency has been under serious challenge in the past few weeks. The Chinese Central Bank Governor, Zhou Xiouchuan, wrote an article on the need for a new global currency to substitute for the role of the US dollar.
Is it an out-of-the-box idea or are there any stronger grounds for such a proposal? This is a really hot topic that has been debated in the last few days and may become an interesting agenda item at the G20 meeting to be held in London this week.
Is there any precedent in history for such a significant change to take place? The answer is yes.
In fact, the change was historic because it was pivotal to the transformation of the International Monetary System at the end of the Second World War.
Breton Woods is not an ordinary place. The village, at the foot of Mt Washington, New Hampshire, United States, is a popular destination for tourists for its beauty. Therefore, as the end of World War II was approaching, the place chosen for the world financial leaders from 44 countries to meet was Breton Woods.
The Financial Conference in Breton Woods lasted from July 1 to July 22, 1944. The US delegation was led by Harry Dexter White while the UK delegation was led by John Maynard Keynes. The conference concluded with the decision to set up three international economic bodies, i.e. the International Monetary Fund, the International Bank for Reconstruction and Development (known as the World Bank) and the International Trade Organization.
As we all know, the IMF and the IBRD were quickly established while the set up of the ITO was
finally diluted into a so-called GATT (General Agreement on Tariffs and Trade) after the US Congress vetoed the ratification of the Havana Charter.
The new international monetary system consisted of a new fixed exchange rate system with the US dollar as the anchor currency. This system was pegged to the price of gold, in which one ounce of gold was decided to have a value of US$35.
In that system, the US government was obliged to exchange US dollars with gold at that specified price. The agency responsible for the smooth functioning of the system was the IMF. This agency was set up to help countries that faced difficulties in maintaining the pegged rate of their currencies to the US dollar.
This history is not widely known. I had the opportunity to do research and dug up the information during my time at the IMF in Washington. The establishment of the International Monetary System scrapped the role of the UK currency, pounds sterling, as the de facto global currency of that era. And the consequences for the UK economy were devastating. It was mind-boggling that the famous John Maynard Keynes did not anticipate the consequences for his country.
The conversion process to a new global currency required the UK government to prepare a huge amount of US dollars for converting billions of pounds sterling that were previously in the reserves of other central banks.
For that purpose, the UK government made billions of dollars’ worth of loan agreements with the US government so such a conversion could take place. Having suffered so much from the World War, such a conversion became an energy sapping exercise that finally destroyed the UK economy.
In the records of the IMF, the UK government was the first government ever to approach the IMF for help. The suffering experienced by the UK economy lasted more than twenty years.
Whether we like it or not, the US economy has served as the engine of global economic growth for more than half a century. Even now with its profound problems, its role is still seriously needed while we are building another epicenter. Therefore, the discussion on the introduction of a new global currency should also look into this consequence to the global economy. The introduction of a new global currency will definitely destroy the US economy which will have strong ramifications on the global economy and the associated geopolitics.
Currently, we have the US dollar and the euro as the most widely used global currencies. The Japanese yen and Chinese yuan have yet to reach such a role. Special Drawing Rights (SDR) a “currency” introduced by the IMF in 1969 also has a limited role in the international economy.
However, the US dollar remains the foremost currency in the reserves of most central banks. Just a 10 percent change in that portfolio of the central banks, to another “global currency”, will mean a hundreds of billions of dollars shift that will bring untold consequences to the US economy. At a time when the US economy is in serious need of funding for its fiscal stimulus, such a shift will definitely reduce the chances for them to get that financing.
However, we also cannot continue to be prisoners of the US mistakes. Structural imbalances in the form of twin deficits of such magnitude certainly become the main recipe for further deterioration and dependence. Even as we speak, the US economy has become so dependent on the generosity of the Chinese government. How long will that kind of situation continue?
The writer is an economist.
