About that Proposal for a New Reserve Currency...

Yes, I am talking about China's proposal that the IMF's special drawing rights or SDR currency be expanded and adopted as the new reserve currency. From Justin Fox we learn this idea is not original. It has been promoted for some time by C. Fred Bergsten. Here is what he had to say about it in December 2007:

There is only one solution to this dilemma that would satisfy all parties: creation of a substitution account at the International Monetary Fund (IMF) through which unwanted dollars could be converted into special drawing rights (SDR)... The idea of a substitution account is simple. Instead of converting dollars into other currencies through the market, depressing the former and strengthening the latter, official holders could deposit their unwanted holdings in a special account at the IMF. They would be credited with a like amount of SDR (or SDR-denominated certificates), which they could use to finance future balance-of-payment deficits and other legitimate needs, redeem at the account itself or transfer to other participants. Hence the asset would be fully liquid.

The fund’s members would authorize it to meet the demand by issuing as many new SDR as needed, which would have no net impact on the global money supply (and hence on world growth or inflation) because the operation would substitute one asset for another. The account would invest the dollar deposits in US securities. If additional backing were deemed necessary, the fund’s gold holdings of $80 billion would more than suffice.

All countries would benefit. Those with dollars that they deem excessive would receive an asset denominated in a basket of currencies (44 percent dollars, 34 percent euros, 11 percent each yen and sterling), achieving in a single stroke the diversification they seek along with market-based yields. They would avoid depressing the dollar excessively, minimizing the loss on their remaining dollar holdings as well as avoiding systemic disruption.

The United States would be spared the risk of higher inflation and potentially much higher interest rates that would stem from an even sharper decline of the dollar...

For these reasons Justin Fox champions the SDR and argues it would be in the best interest of the United States and the rest of the world if it truly became the new reserve currency. The Economist magazine, meanwhile, explains some of the technical details of the SDR while the historian Paul Kennedy wonders if all the buzz about the SDR is just another symptom of a much larger tectonic shift in the global balance of power toward Asia.