Thursday, March 26, 2009

The buck stops here - or does it?

Business Times - 27 Mar 2009

The buck stops here - or does it?


AGAINST the backdrop of next week's G-20 summit in London, several emerging economies led by China and Russia have been promoting the idea of halting the use of the US dollar as the main global reserve currency and replacing it with a new one.

This could pose huge economic problems for the Obama administration which is planing to continue paying for the financial bailout and the economic stimulus by printing more dollars and by selling more Treasury bills to foreign private investors and central banks.

In China which is the largest holder of US dollar assets, with American greenbacks making up more than half of its US$2 trillion in foreign reserves, including US Treasury bonds worth about US$750 billion, there is concern over US deficits that could erode the greenback and the value of China's foreign reserves.

China's central bank governor, Zhou Xiaochuan raised the possibility that the International Monetary Fund's Special Drawing Rights (SDR), a reserve asset whose value is currently based on a basket of the dollar, euro, pound sterling and yen, be expanded to include other global currencies and be used as a super-sovereign reserve currency.

Officials and analysts in Russia as well as in other emerging economies, including India, Brazil, South Korea, Iran and Venezuela have also expressed support for the idea. The Russian government has made it clear that it was planning to raise the issue during the G-20 meeting.

At the same time, both Iran and Venezuela have called on members of the Organization of Petroleum Exporting Countries to price oil against a currency, or a basket of currencies, other than the dollar.

But leading US officials, including President Barack Obama, have dismissed the idea. Similarly, both US Federal Reserve chairman Ben Bernanke and Treasury Secretary Timothy Geithner, testifying in congressional hearing on Tuesday rejected the proposal to bring an end to the global primacy of the US dollar, as they were grilled by Republican Congresswoman Michele Bachmann from Minnesota.

So it came somewhat as a surprise when on Wednesday, during a discussion in the Council on Foreign Relations (CFR), Mr Geithner seemed to be suggesting that he was 'open' to discuss the SDR proposal of China's central bank governor.

Later during the CFR discussion, Mr Geithner did stress that he did not foresee a change in the dollar's centrality as a global reserve currency. 'We will do what's necessary to say we're sustaining confidence in our financial markets,' he said. But the notion that Mr Geithner was seriously considering the Chinese SDR plan seemed to have come as a shock to investors - with the dollar plunging instantly against the euro and yen after he made his remarks.

In any case, most experts seem to agree that while the Chinese may be trying to flex their economic muscle, their SDR proposal is not practical, especially since the US has the power to veto policy decisions at the IMF.

If anything, while challenging the US dollar's global supremacy, the Chinese have actually increased their Treasury holdings by close to 40 per cent, reflecting the continuing confidence other foreign investors and central bankers have in the US currency.

Indeed, as Paul Volcker, the former Federal Reserve chairman, pointed out during a conference in New York on Wednesday, the Chinese 'ignore the fact that they didn't have to buy those dollars in the first place, so they contributed to the problem.'

But there is no doubt that a failure on the part of Washington to fix its ailing financial system could prompt more calls around the world to consider alternatives to a dollar-based system.

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