Rebalancing Global Currency Reserves


At this morning’s superb economic event at the New America Foundation and in testimony before the Senate Foreign Relations Committee yesterday, there was a lot of discussion about China’s recent proposal to consider a move away from the US dollar and towards the use of a new “super-sovereign reserve currency.” The intention according to China’s central bank governor, Zhou Xiaochuan, would be to ultimately “create an international reserve currency that is disconnected from individual nations and is able to remain stable in the long run.”
I have long argued that US policy-makers must take into account the possibility that at some point in the future the US dollar may not play the same role in global finance that it does today and prepare for that contingency.
Since China’s proposal, I have had several conversations with knowledgeable China-hands and economists who argue that the proposal is simply posturing and that the shift away from the US dollar is not likely to happen anytime soon, so why worry? In reply I simply note that in today’s parlous economic environment, taking anything for granted would be a grave mistake – especially when the amounts involved are so very, very large.
The US represents less than 5% of the world’s population and just over 20% of the world’s GDP. And yet, the US dollar represents approximately 64.6% of the world’s official currency reserves. The SDRs that China refers to, and which have received increased attention of late, represent a multi-currency basket under the auspices of the IMF. This basket is weighted as follows – 44% US dollar, 34% Euro, 11% Yen and 11% Pound Sterling.
The IMF estimates that, as of the 3rd quarter of 2008, the most recent period for which reports are available, there were $4,358 billion held in official reserves around the world, with an additional $2,536 billion in unofficial or unallocated reserves – for a total of $6,894 billion total foreign exchange holdings. For simplicity sake, let’s assume that these unofficial reserves are held in a similar proportion to the official ones.
Simple arithmetic demonstrates the size of the shift that the US dollar could possibly suffer if, at some point in the future, its weight in global reserves were to decline to its SDR weighting. A decline from 64.6% to 44% equals 20.6%. 20.6% of $6,894 billion equals $1,420 billion – or about ten percent of US GDP that would be shifted out of the US dollar to achieve SDR weighting.
To be clear, I am not suggesting that this is imminent or even likely. But some holders of currency reserves, in particular the unofficial, or privately held ones, are in the business of anticipating currency movements and trying to profit from them – or at least not lose out. The short term risk is not that China is about to dump its dollar holdings. Rather, it is the trading floors and fund managers around the world, whose job it is to be ahead of the curve, who may well start to re-weight their holdings on the marginally increased probability that this re-weighting might actually occur in the future. As the numbers above suggest, even a relatively small shift could represent a meaningful shift of capital and resulting impact on the dollar’s value.
There are, of course, multiple forces at work in foreign exchange markets and, among the sure-fire ways to lose money in this world are: 1) to play currency markets and 2) to bet against the US and the US dollar. Nevertheless, the fact that this is now likely to be a discussion topic on the agenda for the London Summit, suggests that the US should not take for granted that the US dollar will retain its current role in the world forever. Currencies are traditionally viewed as a reflection of a country’s economic strength. The US cannot lose sight of the crucial role that the “exorbitant privilege” to print the world’s currency provides and do what it can to ensure that this privilege is not lost. We can’t take anything for granted.
— Douglas Rediker


10 comments on “Rebalancing Global Currency Reserves

  1. Warren Coats says:

    An international currency of the sort the Chinese central bank has suggested has existed for 40 years—the IMF’s Special Drawing Right (SDR). Unfortunately, Douglas Rediker’s note in the Washington Note misunderstands and misrepresents what the SDR is and its current and potential significant. The current valuation of the SDR is taken from a basket of currencies with a weight of 44% given to the U.S. dollar. SDR 42.8 billion SDRs (about $63 billion at current exchange rates) have been allocated by the IMF. This might be compared with the amount of credit directly created by the Federal Reserve (Federal Reserve Credit) of about $2 trillion dollars. The number of assets denominated in SDRs is larger than the actual allocated SDRs because all IMF financial activities are denominated in SDR and there may still be the occasional private financial instrument denominated in SDRs. The value of financial instruments and contracts denominated in U.S. dollars and goods (such as oil) priced in dollars is truly huge.
    Mr. Rediker’s statement that “Simple arithmetic demonstrates the size of the shift that the US dollar could possibly suffer if, at some point in the future, its weight in global reserves were to decline to its SDR weighting. A decline from 64.6% to 44% equals 20.6%. 20.6% of $6,894 billion equals $1,420 billion – or about ten percent of US GDP that would be shifted out of the US dollar to achieve SDR weighting.” is wrong and misunderstands the fundamentals of reserve currencies and of the SDR.
    The key issues are how the value of the SDR is determined (the SDR’s value is fixed to a basket of four currency but could be fixed to gold, oil, or any other baskets of currencies, commodities, or goods), how its “base” (“high powered”) quantity is determined and regulated (allocations approved by the member countries of the IMF—international consensus basically), and the extent to which the world chooses to hold and deal in SDRs rather than dollars (which itself will reflect whether individuals and governments are more confident in the valuation of the SDR than the dollar or other possible units and the convenience of dealing in the unit). The fact that the dollar is now 44% of the value of an SDR as currently defined, has nothing what so ever to do with the potential size of a shift from dollars to the SDR if a large number of players decided that they would rather deal in and hold SDRs than dollars.
    An important advantage of an international currency like the SDR surely emphasized by the Chinese (I must confess that I have not yet read the Chinese paper on this subject), is that the U.S. would be subject to much stronger market pressure (in the form of exchange rate adjustments) that would maintain better balance between imports and exports than is now the case. Much has been written about this in the past (some of it by me). Hopefully it can be easily found by those interested. Here is one: “Enhancing the Attractiveness of the SDR” .
    Warren Coats (Chief, SDR Division of the Finance Department of the IMF from 1982-88)


  2. Mr.Murder says:

    In a drive by post I mentioned that we could buy back reserves of currency as a way of hedging the blood loss at this time. The blog ate my homework and I cannot recover the post.
    lo and behold we bought back several billion in reserves today?
    This would put us just past the IMF precipice for their stated basket holdings in the dollar.
    Hedge fund football isn’t just for trust funds anymore.


  3. Frank says:

    Your overall idea is probably correct, but please don’t use the argument, “The US represents less than 5% of the world’s population and just over 20% of the world’s GDP. And yet, the US dollar represents approximately 64.6% of the world’s official currency reserves.” This is intellectual laziness. The US has less than 5% of the world’s population yet spends more than 50% of the world’s Defense outlays. But no one(in the elite) is talking about the US spending significantly less on Defense. The dollar is the world’s reserve currency because of historical facts relating to the economy several decades ago + some big victories in wars + the fact the are the world’s “hegemon”.


  4. rapier says:

    Perhaps some Leprechauns or fairies will create this new money for us but until that time I wouldn’t worry about it too much. The one thing to know is your money will be worth less going forward because money is always worth less going forward. That isn’t necessarily a big worry either usually, except for gold bugs, however when it happens fast which is likely in spurts for the next decade or so it becomes a big deal.
    In the meantime to get your mind off that worry enjoy the usual suspects getting worked up into a frenzy about a world currency. The hilarity has already begun.


  5. pauline says:

    Geithner, Bernanke reject China currency proposal
    Head of China’s central bank says a new reserve currency should be created
    By Polya Lesova, MarketWatch
    March 24, NEW YORK (MarketWatch) — Federal Reserve Board Chairman Ben Bernanke and Treasury Secretary Timothy Geithner flatly rejected on Tuesday a call from a senior Chinese official to drop the dollar as the world’s key reserve currency.
    Zhou Xiaochuan, head of the People’s Bank of China, proposed the creation a new international reserve currency in an essay published on the central bank’s Web site on Monday.
    The proposal is the latest sign of tension between China and the U.S. over important global economic matters. Zhou is expected to attend the Group of 20 meeting in London on April 2 where reform of the global financial system is on the table.
    “The desirable goal of reforming the international monetary system, therefore, is to create an international reserve currency that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies,” Zhou wrote in the essay, according to its English translation on the central bank’s Web site.
    A super-sovereign reserve currency managed by a global institution could be used to both create and control the global liquidity, Zhou wrote.
    more at —


  6. pauline says:

    U.N. panel says world should ditch dollar
    Wed Mar 18, 2009
    By Jeremy Gaunt, European Investment Correspondent
    LUXEMBOURG (Reuters) – A U.N. panel will next week recommend that the world ditch the dollar as its reserve currency in favor of a shared basket of currencies, a member of the panel said on Wednesday, adding to pressure on the dollar.
    Currency specialist Avinash Persaud, a member of the panel of experts, told a Reuters Funds Summit in Luxembourg that the proposal was to create something like the old Ecu, or European currency unit, that was a hard-traded, weighted basket.
    Persaud, chairman of consultants Intelligence Capital and a former currency chief at JPMorgan, said the recommendation would be one of a number delivered to the United Nations on March 25 by the U.N. Commission of Experts on International Financial Reform.
    “It is a good moment to move to a shared reserve currency,” he said.
    Central banks hold their reserves in a variety of currencies and gold, but the dollar has dominated as the most convincing store of value — though its rate has wavered in recent years as the United States ran up huge twin budget and external deficits.
    Some analysts said news of the U.N. panel’s recommendation extended dollar losses because it fed into concerns about the future of the greenback as the main global reserve currency, raising the chances of central bank sales of dollar holdings.
    “Speculation that major central banks would begin rebalancing their FX reserves has risen since the intensification of the dollar’s slide between 2002 and mid-2008,” CMC Markets said in a note.
    Russia is also planning to propose the creation of a new reserve currency, to be issued by international financial institutions, at the April G20 meeting, according to the text of its proposals published on Monday.
    It has significantly reduced the dollar’s share in its own reserves in recent years.
    Persaud said that the United States was concerned that holding the reserve currency made it impossible to run policy, while the rest of world was also unhappy with the generally declining dollar.
    “There is a moment that can be grasped for change,” he said.


  7. JohnH says:

    Of course, none of this would become part of the discussion if the US government bothered to manage its economy well.
    However, several trends are converging to put pressure on the dollar. As Douglas mentioned, currencies usually reflect underlying economic strength. The share of the US economy is 20% and dropping.
    Part of the problem is the strong dollar policy, which has made most US exports uncompetitive (except for junk financial instruments), penalizing manufacturing. (Agriculture competes only due to massive subsidies.)
    Then there is the issue of the multiple deficits: import/export, capital account, federal budget, and consumer borrowing, which are creating financial reserves held increasingly by foreigners.
    Finally, there is the issue of the rule law and its failures in financial markets. Historically, foreigners invested in US financial instruments in part because they represented a safe haven. With the shenanigans of AIG and their enablers (Robert Rubin, Alan Greenspan, etc.) the US is still regarded as a safe haven only because other places are worse. How long can it be before another major market (Japan, EU) capitalizes on US fumbling and seizes the golden opportunity to become the safe haven of choice. Ultimately, that will trigger the demise of the dollar.


  8. Kerub says:

    can be, the SRD basket composition, a hit to how many dollars China (and Japan, the second after) are going to sell?
    one third.


  9. Matt says:

    It’s amazing what a Drudge Report headline plus a nationally-broadcast, prime-time question to the President can do.


  10. ... says:

    i linked to the chinese proposal here a few days ago with not a peep from anyone… glad to see those in the know actually thought to comment on it… ever since fiat currencies took over with their disconnect from anything concrete ie – gold – the world has been subject to financial hanky panky on a grand scale… this will continue and while the chinese plan is a step towards more sanity, it still is essentially more of the same…. money is power and controlling money is all about power.. at present the chinese are moving towards dominant world power, while the usa is moving in the reverse.. it makes sense that china would be setting the agenda and eventually will come to dictate the direction globally, but not without major resistance from the usa…


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