Since its emergence as the global reserve currency after the Second World War, the United States (“US”) Dollar’s role as world’s currency has not faced the level of scrutiny it currently faces. Following the demystification of the US economy by the Financial Crisis of 2007-2009, and resulting fiscal deficit, there have been calls to review the role of the US Dollar as the global reserve currency.
America enjoys several benefits from this role. Seigniorage, the income a country generates by issuing its currency, appears to be one. The profit derived from the issuance of additional currency to non US residents who hold US notes and coins is estimated to be about $10 billion annually. Also, the high demand for the Dollar ensures its protection from fluctuation. The global demand for the Dollar has in effect, insulated it from volatility. There are also socio-political benefits. America is the world’s largest economy and considered to be the bankers to the world, allowing it wield enormous political influence. As Henry Kissinger said, “he, who controls money, controls the world.”
The US also bears the burdens attached to such responsibility. The high global demand for the Dollar, and the need to maintain liquidity, makes it difficult for the US government to run a surplus budget. The exposure of the US economy to creditors such as China has significant disadvantages to America. The prophecy that the Chinese government will take a swipe at the US in order to overtake it as the world’s leading power is not improbable. The effect of China dumping the over 11 million US treasury securities it currently holds will collapse the US economy. China has in recent times, had the ability to artificially manipulate the value of the Dollar by intervening in its own currency by largely underpricing its Renminbi when compared to the Dollar, thereby leaving it undervalued.
The global economy has benefited from the US Dollar being the global reserve currency. Its use as a global medium of exchange cannot be overstated; largely reducing the cost of international transaction and greatly reducing currency risk that may arise in transacting with more than two currencies. The value of international trade that is invoiced in Dollars is much larger than the total trade conducted by the US and countries with currencies linked to the greenback. Also most countries can protect the value of their currencies by intervening with their Dollar dominated foreign reserves. Where the market forces are not favorable to a country’s currency (the supply of the currency outweighs the demand, which will lead to drop in value of the currency), the country can purchase the excess supply of its currency using its Dollar reserves. This stabilizes the value of its currency. Though this act of intervention divides economists, it is still common practice among numerous countries, notably Nigeria.
However, these benefits also come with drawbacks. One of such is that the US can take certain monetary steps without considering the global economy. The Stiglitz Report claimed that “US monetary policies were implemented with little consideration of their impact on global aggregate demand or demands for global liquidity and were thus a cause of instability in exchange rates and global activity” in reference to America’s response to the excess Dollar liquidity in the 1970s. There is the increased risk of doomsday if the Dollar fails. The “Triffin Dilemma” propounded by renowned economist Robert Triffin, asserts that where a single currency (such as the Dollar) acts as the global reserve currency, the increased need to fuel global liquidity will lead to an increase in the supply of that currency. This will result in an increased budget deficit of that country supplying the currency which will one day erode the value of that currency.
The world has put its eggs in one basket. Will the global economy survive the failure of the Dollar? Is the US really too big to fail? Using the Dollar as the global currency reserve creates a systemic risk to the world that is too large to overlook. The question on everyone’s lips is, “to be or not to be”? Has the Dollar outspent its usefulness as the global reserve currency? Is it time for the Dollar to vacate this position for another currency or group of currencies?
March 23, 2009 is a day of significant importance. On this day, Zhou Xiaochuan the Governor of Central Bank of US’ largest creditor, China, called for a replacement of the Dollar as the dominant world currency. He suggested the creation of an international reserve currency issued to a stable benchmark, disconnected from individual nations. Should China’s Renminbi replace the Dollars as the world’s global reserve currency? China has relaxed restrictions on its currency allowing foreign holders trade its currency to some extent. This has encouraged numerous trade partners like Nigeria to adopt the Renminbi as a tradeable currency. However, China’s currency regulation is far from perfect. There are allegations that China is intervening in its currency, as the rate its currency currently exchanges, does not reflect the growth in its economy. There is no guaranteed independence of the Chinese Central Bank from the political leadership of the country, a major flaw in its system. The alteration of the Renminbi for the US Dollar does not remove the systemic risk of the use of one currency as global reserve currency.
Will a dual or multiple global reserve currency system solve this problem? This system will solve the primary problem of over reliance on only one currency as the global reserve currency. However, this system also brings along its own complexities. First, it is more complex to transact in more than one currency. Secondly, where the dual currency system applies, holders automatically double the currency risk they face.
The ‘savior’ appears to have arrived or so it seems. The proposed system is an improvement on Keynesian idea of an international reserve currency issued by a supranational bank. The Stigitz Report suggests the Special Deposit Receipts (“SDR”) issued by the IMF be utilized as the global reserve currency. The report further proposes that a Global Reserve Bank should be set-up by the IMF to run this. Global currencies will be issued to the IMF in exchange for SDRs in similar quotas with the IMF quota creating a global security backed by a number of currencies. The exchange rate of the SDR will be an average of all the currencies held.
In conclusion, it is clear that though the Dollar is not dead, it is terminally ill. However, the world should not be quick to jettison the US Dollar until a well-structured alternative is available. The proposed SDR appears to be a good alternative; the intricacies have to be properly worked on and all nations be carried along in the process of establishing the new global reserve currency.