Research

The new currency deal: Alternatives to the dollar

The American dollar is the major currency for commerce around the globe. By some estimates, the dollar is used in nearly half of all world trade, and has long played a vital role in domestic economies from Africa to the former USSR. In a wide range of countries like Cambodia, East Timor, Ecuador and Panama, the dollar is either the official or default currency. Amidst the current economic crisis, many are retreating from the dollar to gold and other currencies. Far from reason to worry, economists at the "The Currency of Trade" conference convened in Beijing recently said that the dominance of the dollar is a relatively recent occurrence. What will replace it is still to be determined.

2010-04-01

The American dollar is not only the legal tender throughout the United States; it is also the major currency for commerce around the globe. By some estimates, the dollar is used in nearly half of all world trade, and has long played a vital role in domestic economies from Africa to the former USSR.

In a wide range of countries like Cambodia, East Timor, Ecuador and Panama, the dollar is either the official or default currency. Yet amidst the current economic crisis, many are retreating from the dollar to gold and other currencies. Far from reason to worry, economists at the "The Currency of Trade" conference convened in Beijing recently said that the dominance of the dollar is a relatively recent occurrence.

They detailed how the American dollar really came of age following the tumult of the Depression and the ensuing World War II. Previously, a variety of different currencies competed vigorously for regional trade and influence, often with chaotic consequences. "The dollar brought stability to the world," noted Hans Genberg, visiting advisor, Bank for International Settlements and former executive director of research at Hong Kong Monetary Authority.

But now, with the dollar in decline, many wonder if the glory days of the Greenback are gone forever. As the euro soars in strength, some pundits say it may emerge as a realistic rival to replace the dollar as the major global currency of trade. Others speculate that the time has come for a change from an over-reliance on any one giant global currency, especially as the weaknesses and excesses of the American economy contributed so heavily to the catastrophic worldwide financial crisis.

From Bretton Woods to Beijing

In 1944, the United Nations Monetary Fund convened in Bretton Woods, New Hampshire and established the policy of pegging currencies against the U.S. dollar in order to stabilize the world economy. The Bretton Woods accord set fixed exchange rates and established the International Monetary Fund. "Bretton Woods made great contributions to the global economy and stability," noted He Weiwen, one of China's top economic commentators.

While praising the multi-national financial pact that helped restore order to global markets after World War II, he said the future might dictate a radical departure from the system that served the world so well for more than half a century. "A return is just not possible." He, deputy director of the China Institute for Open Economy, gave an overview of the global currency system during "The Currency of Trade," the second in a series on U.S.-China trade relations organized by the Kearny Alliance and Arizona State University.

Proposed modifications in the global currency system, largely unchanged from the days of Bretton Woods in the 1940s, was one of the key topics of the forum. Speakers detailed the role the euro had played in reshaping our modern financial landscape, along with the arduous steps taken to bring it into circulation. The eEuro roadmap is particularly relevant to those calling for the development of a new Asia-wide currency.

Various scenarios under which such an Asian currency might be coined were discussed, along with schemes for a new kind of global currency altogether, not tied to any one economic system. Located in the Chinese capital, held amidst mounting calls for more reform in the trade and valuation of the Chinese currency, the conference was a platform for many speakers to discuss the concerns about what role China might play in the creation of an Asia-wide currency, or in support of any global monetary unit.

"China has a long way to go," conceded Tao Wang, head of China Economic Research for UBS Securities. Full convertibility of the Yuan (or capital account liberalization), she said, is Beijing's aim, but there is still a path ahead simply to prepare the yuan exchange rate for greater flexibility. The Chinese currency is not a fully convertible currency, and is not used for trade outside of China until recently in Hong Kong and other neighbor regions.

Recent measures have allowed a nominal internationalization of the yuan, and Beijing has allowed the Yuan to appreciate by 20 percent against the dollar. "There are many, many steps before the yuan can be an international or reserve currency," Tao Wang noted. "Really, we have to see what China can handle."

She said relaxing capital account controls and allow the currency to rise in valuation — which many accuse Beijing of keeping undervalued to maintain what they say is an unfair trade advantage — are only the first, and perhaps easiest steps in the process.

China must also develop its bond market, increase transparency in lending and develop more financial sector oversight before the yuan can become a realistic international currency. "Change will be slow, and gradual," she predicted. "The Big Bang way is not the Chinese way."

Switch to SDRs?

There has been a buzz around Asian economic circles about a new type of currency, which many envision as an Asian-style euro, as well as a new monetary unit backed not by any single nation or group of nations, but by an organization of some kind. Much of this talk has focused upon SDRs (Special Drawing Rights), which have been used by the International Monetary Fund for decades.

In March 2009, Zhou Xiaochuan, governor of the People's Bank of China, proposed adopting the SDR as a worldwide reserve currency in place of the U.S. dollar. Russia has also touted the potential of such a scheme. Advocates say the SDR has many advantages, including the fact that it exists and is used by the IMF and other organizations. Some countries use the unit as a currency peg.

And while this hasn't been the case for decades, SDRs were originally devised to fill needs similar to the current situation. Introduced by the IMF in 1969, SDRs were created to support the fixed exchange system that came out of Bretton Woods: it depended on the availability of dollars and gold, but as global trade boomed, supplies could not keep pace.

The SDR was envisioned as a kind of reserve currency that could fill the gap, helping countries with inadequate reserves to acquire an internationally recognized currency to maintain exchange rates. A change to floating exchange rates and the rise of international capital and lending markets reduced the need for the SDRs, yet they are still set to a daily rate against a basket of currencies, and used in some international exchanges — like the transfer of roaming charges between international mobile operators.

But many economists see little chance that SDRs would assume a major role in global trade. "The big problem with SDRs," noted UBS' Tao Wang, "is at the end of the day, when you need to settle accounts, and pay bills, you still need a currency of trade, which is usually U.S. dollars."

Michael Dooley, professor of economics at the University of California, Santa Cruz, added: "SDRs aren't a replacement for dollars. They are already here now. You can already use them, but nobody does. A currency that nobody wants is a bad idea." Others noted that lack of liquidity, volume and the implied support of a government are the big reasons SDRs will not be the replacement.

Enter the Asian euro

Prospects for the development of an Asian-wide currency, perhaps modeled upon the euro, seems a better bet. In fact, such a currency has been talked about for over a decade, according to Zhuang Jian, senior economist at the Asian Development Bank Resident Mission in the PRC. Discussions began during the Asian Financial Crisis, which devastated most Asian economies in 1997-98.

Support for such a currency waned as the crisis passed, he noted, but said talks had been revived in the years before the current financial meltdown. In 2005, ministers from China, Japan and South Korea held a summit and agreed to send a note to the ADB, pushing the possibility of some currency linkage. Research is ongoing in Japan on this "Asian Monetary Unit." He noted that numerous obstacles remained but added: "We look at the euro's evolution."

Wolfgang Munchau, associate editor of the Financial Times, was even more cautious as he detailed the long emergence of Europe's common currency. While most are aware of its birth a decade ago, he said, few realize it was conceived many decades before. "We hear that an Asian currency could take 30 or 40 years to come about, and this is not unrealistic. It took the euro that long."

Munchau detailed the enormous process of putting in place frameworks and building institutions like the European Central Bank, long before the currency was approved and introduced. "The process was staggering, partly because no one had done it before."

While Asia might well benefit from the lessons learned in the establishment of the euro, few believe an Asian-style euro could emerge anytime soon. Financial leaders are concerned that in time of crisis, when intervention may be needed, it would be hard to coordinate the number of countries that would be involved.

Bottom Line:

• The American dollar is the major currency for commerce around the globe, used in nearly half of all world trade, and serves as the de facto currency in countries from Cambodia and East Timor to Ecuador and Panama.
• Many say one lesson of the recent economic crisis is not to be overly dependent on one currency, like the dollar. Many advocate the development of an Asian currency, or greater international trade in the Chinese yuan.
• China has a long way to go before its currency can trade widely. "Change will be slow, and gradual," said Tao Wang of UBS. "The Big Bang way is not the Chinese way."
• Both China and Russia have touted SDRs (Special Drawing Rights), issued by the IMF, as a new alternative currency. But some economists are cool to the idea, noting that they are already available and little used.
• China, Japan and South Korea — the region's powerhouse economies — are talking about developing an "Asian Monetary Unit," that could be modeled on the euro. Most believe implementation would be many decades away.
• Another alternative is a regional fund, tapping the vast international reserves held in Asia. This could serve an Asian currency board, intervening to prop up weak currencies and protecting against another financial meltdown.

Economics