Mr Zhou Xiaochuan's indicated in this speech...I quote 'The outbreak of the current crisis and its spillover in the world have confronted us with a long-existing but still unanswered question,i.e., what kind of international reserve currency do we need to secure global financial stability and facilitate world economic growth, which was one of the purposes for establishing the IMF? There were various institutional arrangements in an attempt to find a solution, including the Silver Standard, the Gold Standard, the Gold Exchange Standard and the Bretton Woods system. The above question, however, as the ongoing financial crisis demonstrates, is far from being solved, and has become even more severe due to the inherent weaknesses of the current international monetary system.'...unquote
He continued...'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.'
Beijing indicated that the dollar’s role could eventually be taken over by the IMF’s so-called Special Drawing Right (SDR), a quasi-currency that was created in 1969. Mr Zhou argued that the SDR has the potential to act as a 'super-sovereign' reserve currency, spanning national jurisdictions. In turn, he suggested that this could not only eliminate the risks associated with paper fiat currencies, such as the dollar and pound – which are backed only by the credit of the issuing country, rather than by gold – but would make it possible to manage global liquidity and imbalances more effectively.
He said: 'The role of the SDR has not been put into full play due to the limitations on its allocation and the scope of its uses. However, it serves as the light in the tunnel for the reform of the international monetary system.'
Mr Zhou suggested a shift by which the SDR could form the anchor of a new global exchange-rate system, replacing the former Bretton Woods system of fixed but adjustable exchange rates, which collapsed in 1971. Since then, most large Western economies have had floating currencies, while nations such as China have managed their exchange rate, creating incompatibilities blamed for stoking up the damaging imbalances.
'When a country’s currency is no longer used as the yardstick of global trade, and as the benchmark for other currencies, the exchange-rate policy of that country would be far more effective in adjusting economic imbalances,' Mr Zhou said.
The IMF's SDR, although denominated in US dollars, has a nominal value derived from a basket of currencies. This basket is composed of Japanese Yen (11%), US Dollars (44%), British Pounds (11%) and Euros (34%), and the proportion each of these four currencies contribute to the nominal value of a SDR, which is reevaluated every five years. For the period of 2006-2010, one SDR is the sum of 0.6320 US Dollars, 0.4100 euro, 18.4 Japanese yen and 0.0903 pound sterling.
Due to varying exchange rates, the relative value of each currency varies continuously and thus the value of the SDR fluctuates. The IMF fixes daily the value of one SDR in terms of US dollars based on the exchange rates of the constituent currencies. The latest US dollar valuation of the SDR is always available from the International Monetary Fund web site.
Recently, Yu Yongding (left), member of the state-backed Chinese Academy of Social Sciences and former central bank adviser indicated that U.S. Treasuries fail to provide safety or liquidity when it comes to managing China’s US $2.45 trillion foreign-exchange reserves.
China is unable to sell the securities in a 'big way' and a 'scary trajectory' of budget deficits and a growing supply of U.S. dollars put their value at risk, he said.
The State Administration of Foreign Exchange, which manages the nation’s reserves, said last month that U.S. government debt has the benefits of 'relatively good' safety, liquidity, low trading costs and market capacity. China’s holdings of Treasuries, the largest outside of the U.S., totaled US $867.7 billion at the end of May, down from US $900.2 billion in April and a recordUS $939.9 billion in July 2009.
To help cool demand for the securities, China needs to curb the growth of its foreign reserves by intervening less in the currency market, Yu said. The People’s Bank of China said June 19 it would let the yuan float with reference to a basket of currencies, ending a two-year-old dollar peg.
The yuan has since appreciated 0.8% to 6.773 per dollar and analysts predict the currency will end the year at 6.67, based on the median estimate. China limits appreciation by buying dollars, fueling its demand for Treasuries.
'China has to depend more on demand and supply in the foreign exchange market for the determination of the yuan exchange rate,' Yu wrote. 'Only God knows how much of the value that China has stored in the U.S. government securities will be left in the future when China needs to run down its reserves.'
'The U.S. government has strong incentives to reduce its real burden of debt through inflation and dollar devaluation,' he said. 'Whichever way it is, the yuan-recorded market value of Treasuries will fall, causing huge capital losses to China’s central bank.'
The Sliding Dollar
The dollar has weakened against all 16 major currencies monitored by Bloomberg in the past month, sliding 5.4 percent versus the euro and 4.7 percent against the pound. The Dollar Index, which the ICE futures exchange uses to track the greenback against the currencies of six major U.S. trading partners, is headed for its lowest close since April 15.
Premier Wen Jiabao in March urged the U.S. to take 'concrete steps' to reassure investors about the safety of dollar assets after President Barack Obama stepped up spending to help end a recession. The White House predicts the U.S. budget deficit will hit a record $1.47 trillion this year, about 10 percent of gross domestic product.
An 'appropriate' policy for China would be to allocate its reserves with reference to the weightings of Special Drawing Rights, a unit of account of the International Monetary Fund, Yu said in May. China bought a net 735.2 billion yen ($8.3 billion) of Japanese bonds in May, doubling purchases for this year.
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