China Wants SDRs to Replace the Dollar as the Global Reserve Currency

Actions speak louder than words. Less than a week after he wrote an article proposing that the dollar be replaced as the world's international reserve currency, Zhou Xiaochuan, China's central bank governor, signed off on a $10.2 billion currency swap with Argentina. Under the terms of the deal, China will receive renminbi instead of dollars for its exports to Latin America. An Associated Press report notes that Beijing has signed "similar deals to bypass the U.S. currency with South Korea, Malaysia, Belarus and Indonesia." Such swaps -- all signed since December -- add up to more than $95 billion.

These facts will undoubtedly influence discussions at the G-20 summit in London this week. Over the past month China has been pushing to end the dollar's dominance as a reserve currency for several reasons, including its massive stockpile of U.S. investments. The Financial Times wrote in an editorial titled "China's plan to end the dollar era" on March 24: The "People's Republic has over-exposed itself to the U.S., piling up dollar-denominated securities. In January, its stock of U.S. Treasuries was about $739 billion – a startling leap from $535 billion in June last year."

Moreover, China is worried that Washington's tendency to print and throw dollars at the economic crisis facing the U.S. will "hurt the dollar and hence the value of China's huge foreign reserves, of which around two-thirds are in dollars," according to The Economist. The Chinese proposal involves dealing with these problems by enhancing the role of the International Monetary Fund's Special Drawing Rights (SDRs), so that over time SDRs could replace the dollar as the global reserve currency. (The value of SDRs is derived from a weighted average of four currencies: the dollar, euro, yen and pound.)

China's views are starting to gain support. Russian President Dmitry Medvedev has called upon the G-20 leaders to explore alternatives to the dollar as a reserve currency. According to Reuters, Medvedev told the BBC in an interview that "it is quite obvious that the existing currency system has not coped with the existing challenges." More significantly, Nobel laureate Joseph Stiglitz, who heads a panel of U.N. experts looking into the financial crisis, said last week that "a reserve currency system based on [SDRs] instead of the U.S. dollar could be phased in within a year." It might possibly take longer, he added, since a key issue to be resolved is how the SDRs would be allocated to different countries.

Not to be outdone by the Chinese, Venezuelan President Hugo Chavez has called for the creation of a "new oil-backed currency to challenge the U.S. dollar." Chavez sought support for his proposal this week from among the Arab states at a conference of Arab and Latin American countries in Doha, Qatar. It is difficult to believe, though, that the petro-currency notion will go anywhere. The Gulf states as well as Saudi Arabia are too close to the U.S. for the idea to develop real legs.

Weighing against this tide of opinions that aim to topple the dollar from reserve currency status is a single, stark fact: Given the fragility of the global economy, confidence in the dollar is more important than ever to get the world back on the track to recovery. World Bank president Robert Zoellick, who spoke at Wharton recently, argued today that "a dollar-based system and a strong dollar will be critical to pull us out of this hole." He also predicted that the dollar would remain the principal reserve currency, although "over time you will see discussions about the role of the dollar."

In short, the dollar may be in the hot seat -- but don't count it out for now. In the long run, though, it's anybody's guess.