Just weeks before the Group of 20 meeting in London, where leaders of industrial and developing nations will meet, China has proposed revolutionising a key part of the global financial system by replacing the dollar as the world's global reserve currency with a super-sovereign reserve currency. Zhou Xiaochuan, governor of the People's Bank of China, published the proposal on the bank's website in both Chinese and English this week.
Zhou is building on an idea tabled earlier this month by a group of countries including China, India and Russia.
Without explicitly referring to the dollar, he talks about the problems inherent in using a national currency as the global reserve -- the main problem being that a country has to balance its domestic monetary policy goals with the international responsibilities of its currency. And when a national currency is used to price commodities and trade, the monetary authority issuing the cash will be unable to resolve economic balances by adjusting its exchange rate.
But the US does benefit in some ways from having the main global reserve currency since it allows for easy borrowing from other countries, keeps interest rates low and stimulates spending. Of course, this has proven to be a double-edged sword for the US, since excessive borrowing contributed to the subprime crisis.
Instead, Zhou suggests a super-sovereign reserve currency, based on special drawing rights (SDR), which in turn would be based on a basket of major currencies used in international trade. The responsibility of looking after the SDRs will fall to the International Monetary Fund (IMF).
"A super-sovereign reserve currency managed by a global institution could be used to both create and control global liquidity," says Zhou. "And when a country's currency is no longer used as the yardstick for global trade and as the benchmark for other currencies, the exchange rate policy of the country would be far more effective in adjusting economic balances," thereby reducing the probability of further economic crises.
The idea of sidelining the dollar has, as you might expect, not gone down well in the US where President Barrack Obama said that the dollar is "extraordinary strong" and that there is no need for a global currency.
The proposal "has the potential to lead to one of the most profound reforms of the global monetary system in the coming decades," says Jun Ma, Deutsche Bank's chief economist for Greater China. He admits, though, that to implement the proposal would be an extremely complicated task.
China is clearly concerned about its $1.5 trillion exposure to the US currency, which is an unavoidable consequence of the current financial system. As China stacks up dollars from its massive trade surplus, it has little alternative but to put them into dollar-based assets - primarily Treasury bills and agency debt.
In recent months, China and the US have engaged in a public spat over currencies: only a few days after Obama assumed the presidency, Treasury secretary Timothy Geithner labelled China a currency manipulator. And earlier this month, Chinese premier Wen Jiabao said at a press conference that he was worried about China's Treasury holdings and that he wanted an assurance that China's investments were safe.
Addressing delegates of the Credit Suisse Asian Investment Conference in Hong Kong this week, economist Professor Joseph Stiglitz said the dollar is no longer a good store of value. And much of his audience seemed to concur. Against this backdrop, the G20 meeting looks set for some heated debate.
