Wants SDRs to Replace the Dollar as the Global Reserve Currency

Actions speak louder than words. Less than a week after
he wrote an article proposing that the dollar be replaced as the world’s
international reserve currency, Zhou Xiaochuan, China’s central bank governor,
signed off on a $10.2 billion currency swap with Argentina. Under the terms of
the deal, China will receive renminbi instead of dollars for its exports to
Latin America. An Associated
Press report
notes that Beijing has signed “similar deals to bypass the
U.S. currency with South Korea, Malaysia, Belarus and Indonesia.” Such swaps — all signed since December — add up to more than $95 billion.

These facts will undoubtedly influence discussions at the
G-20 summit in London this week. Over the past month China has been pushing to
end the dollar’s dominance as a reserve currency for several reasons, including
its massive stockpile of U.S. investments. The Financial Times wrote in an editorial titled “China’s
plan to end the dollar era
” on March 24: The “People’s Republic has over-exposed
itself to the U.S., piling up dollar-denominated securities. In January, its stock
of U.S. Treasuries was about $739 billion – a startling leap from $535 billion
in June last year.”

Moreover, China is worried that Washington’s tendency
to print and throw dollars at the economic crisis facing the U.S. will “hurt
the dollar and hence the value of China’s huge foreign reserves, of which
around two-thirds are in dollars,” according
to The Economist
. The Chinese
proposal involves dealing with these problems by enhancing the role of the
International Monetary Fund’s Special Drawing Rights (SDRs), so that over time
SDRs could replace the dollar as the global reserve currency. (The value of
SDRs is derived from a weighted average of four currencies: the dollar, euro,
yen and pound.)

China’s views are starting to gain support. Russian President Dmitry Medvedev has called
upon the G-20 leaders to explore alternatives to the dollar as a reserve
currency. According to Reuters,
Medvedev told the BBC in an interview that “it is quite obvious that the
existing currency system has not coped with the existing challenges.” More
significantly, Nobel laureate Joseph Stiglitz, who heads a panel of U.N.
experts looking into the financial crisis, said
last week
that “a reserve currency system based on [SDRs] instead of the
U.S. dollar could be phased in within a year.” It might possibly take longer,
he added, since a key issue to be resolved is how the SDRs would be allocated
to different countries.

Not to be outdone by the Chinese, Venezuelan President Hugo Chavez has called
for the creation of a “new oil-backed currency to challenge the U.S. dollar.”
Chavez sought
support for his proposal
this week from among the Arab states at a
conference of Arab and Latin American countries in Doha, Qatar. It is difficult
to believe, though, that the petro-currency notion will go anywhere. The Gulf
states as well as Saudi Arabia are too close to the U.S. for the idea to
develop real legs.

Weighing against this tide of opinions that aim to topple the dollar from
reserve currency status is a single, stark fact: Given the fragility of the global
economy, confidence in the dollar is more important than ever to get the world
back on the track to recovery. World Bank president Robert Zoellick, who spoke
at Wharton recently
, argued today that “a dollar-based system and a strong
dollar will be critical to pull us out of this hole.” He also predicted that the dollar
would remain the principal reserve currency
, although “over time you will
see discussions about the role of the dollar.”

In short, the dollar may be in the hot seat — but don’t count it out for now. In
the long run, though, it’s anybody’s guess.