Earlier this week, China triggered a worldwide debate on the fate of the international monetary system when its central bank governor Zhou Xiaochuan released a paper suggesting the need for a new global reserve currency, one that is super-sovereign. That’s an important debate to have, not just for governments to craft smarter policies, but also to remind the world of the dangers of economic profligacy.
China’s concern, echoing Russia’s from earlier this month, is that the sins of the US are being passed on to to the world. It’s not an accident that we’re having this debate a week after the US Federal Reserve expanded its balance sheet by at least $1 trillion. The Fed’s attempts to reflate its way out of this recession may or may not work, but it’s already having an impact on the dollar, which has tumbled 4% against the euro since then.
US fiscal excesses are no less. Barack Obama’s recent $787 billion stimulus plan, along with $410 billion more of spending, is only the latest and largest instance. US debt, for the most part, has been ballooning since the Bush years. This debt comprises about one-third of China’s $1.9 trillion of foreign exchange reserves. It’s no surprise, then, that China is groaning as the dollar falls.
The problem here is simple: The US, since the collapse of the Bretton Woods system in early 1970s, has had the unique privilege that comes with the reserve currency status of printing its own money to finance its external debts. It’s violated this privilege consistently last decade, running up not just budget deficits but also implementing an easy money policy that flooded global markets with excess liquidity. It’s again violating that same privilege with its latest salvoes.
The solution, however, isn’t so simple. Like India’s own Montek Singh Ahluwalia did at Davos earlier this year, Zhou recommends greater use of the International Monetary Fund’s (IMF) Special Drawing Rights, a basket of currencies that nations could use to park their reserves. But how IMF takes care of this basket and allocates reserves are big questions, ones that can’t be solved overnight. The world needs a new Bretton Woods conference for that.
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