A global currency? No. A dollar substitute? Maybe.

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The world needs a global currency because the dollar is becoming too risky, the head of China’s central bank argued this week.

The proposal has no immediate future. President Obama shot it down at Tuesday night’s press conference: “I don’t believe that there’s a need for a global currency.”

But in a rational and reasoned paper posted on the Web, Governor Zhou Xiaochuan of the People’s Bank of China sees “a light in the tunnel” in Special Drawing Rights (SDRs), created in 1969 by the International Monetary Fund (IMF). Over a “long time,” he argues, SDRs could replace the greenback as the primary currency that nations hold in their international reserves.

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SDRs more stable

Now used in occasional accounting transactions between nations and international institutions, SDRs have steadier value than the dollar because they’re based on a pool of major currencies. International concerns about the greenback are rising because of America’s wide budget and trade deficits.

“The outbreak of the [financial] crisis and its spillover in the entire world reflect the inherent vulnerabilities and systemic risks in the existing international monetary system,” Mr. Zhou wrote. He called for creating “an international reserve currency that is disconnected from individual nations and is able to remain stable in the long run.”

China has a strong interest in this issue. It holds perhaps $1.3 trillion of US Treasury and other dollar investments in its international reserves. These piled up rapidly in recent years as China sold far more toys, clothing, tools, and other goods to the US than it bought in the way of airplanes, machinery, paper, etc., from America.

US inflation ahead?

In an attempt to revive the American economy, Washington has been pumping vast amounts of dollars into the economy through extra federal spending and an extraordinarily generous monetary policy. This has aroused fears internationally that this policy might lead eventually to high inflation, in effect shrinking the value of dollar reserves. Foreigners withdrew capital from the US in record amounts in January.

There’s been talk that China itself might attempt to limit any losses on its stack of dollars by diversifying its reserves into euros and yen, or maybe even other currencies and commodities. But such a move could devalue the dollar on foreign exchange markets, result in Chinese losses on its dollar reserves, and threaten a global financial panic.

Zhou apparently recognizes chances of creating a really new international currency are probably zero. But by highlighting SDRs, Zhou, who has a doctorate in economic systems engineering from Tsinghua University, is recalling another period when the dollar was in trouble.

Trouble in 1969

At that time, the US dollar was tied to gold. France in particular had been complaining for years about the “unfair” privileges given the dollar by its role as the prime reserve currency. SDRs addressed this concern as their value is based on a pool of major currencies rather than just one.

In a 1969 Monitor article about the creation of SDRs, I called it a “historic event.” Later developments, though, diminished any role for what was frequently called “paper gold.” The Bretton Woods international monetary system fell apart in 1973 when the US devalued the dollar against gold and subsequently let the dollar’s price be set on foreign exchange markets.

Today there are only 21.4 billion SDRs, held largely by central banks. A US dollar buys about 0.66 SDRs today.

Substitute for greenback

In late 2007, C. Fred Bergsten, director of the Peterson Institute for International Economics in Washington, proposed the creation of a “substitution account” at the IMF that could use SDRs to buy unwanted US dollars from central banks of China and other nations. Foreigners, including sovereign wealth funds and private investors now hold some $20 trillion in dollars. His idea was to avoid “the mother of all monetary crisis” should the dollar’s value plunge, lowering US living standards as import prices rise dramatically.

As an official at the US Treasury at a time of double-digit dollar inflation, Dr. Bergsten had negotiated with other key nations for creation of such an account and came close to an agreement in 1980, he recalls. Since his proposal for a substitution account first appeared in the Financial Times, he has had requests for more details from Chinese officials.

Treasury Secretary Timothy Geithner and another high Treasury official, Ted Truman, are familiar with the idea. He suspects Mr. Geithner might resurrect the idea later this year. A 1997 proposal for doubling the number of SDRs would take only US approval to come into effect That would in effect modestly expand the world’s supply of credit (money) at a time of a global slump. This could be economically helpful.

Zhou, in his paper, outlines a “grand” plan of actions to expand the role of SDRs that could lead them to become “a super-sovereign reserve currency.” He adds, “It should be a gradual process that yields win-win results for all.”

China might consider any losses on its dollar holdings as a “subsidy” for the massive creation of jobs resulting from its huge trade surpluses, Bergsten suggested.

– This blog was contributed by Monitor columnist David R. Francis.

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