The ongoing financial crisis exemplifies the hopes that once used to be reposed on the dollar and SDRs by international bankers, money-managers and developing economies.
Initially alluded to as ?paper gold?, the SDR has always been as strong (or, as weak) as its constituents?its composition being, US$ (44%), Eur (34%), Japanese yen (11%) and sterling (11%). But that precisely is what is occasioning discomfort in China.
Gyrations in the value of the dollar vis-?-vis other major currencies and SDRs are especially worrisome for China since, very often, they imply a weakening of the world?s first-ranked reserve currency. The story is complete once one appreciates the mammoth sums that Beijing has invested in US Treasury Bills. Already in September 2008, Beijing had invested more than 60% of its entire, $1.9 trillion balance of payments surplus in official US debt instruments! The forex holdings of the other three Bric economies at that time were Russia ($475 billion), India ($253 billion) and Brazil ($201 billion).
It is this undue dependence on the dollar which explains China?s greater than usual eagerness to exit the narrowly based international unit of account that was created in 1969 to afford the US respite from the iron discipline of the its parity with gold. But the tables have truly turned: today, it is Beijing?s turn to lament the lack of fixed parities. China also rues the low level of SDR use?a thing which could change once it is underpinned by some additional, robust, currencies (including, of course, its own).
China actually occasioned quite a stir when it suggested, ahead of this year?s G-20?s London Summit, that the world should move towards greater usage of the IMF?s SDRs created in 1969.
A SDR based on a greater number of currencies would actually be much less susceptible to the pulls and pushes of individual ones. That would be a great help since then its value would be determined by three important targets?including the concerned government?s commitment to fight inflation, maintain prudent levels of indebtedness, and enforce a ceiling on money supply (which are also the three most important Maastricht cCriteria of the EU.)
In fact, Russia too desires a harder international unit of account, and has suggested a return to the gold standard. President Medvedev has stressed the need to diversify the constituent components of the reserve currency basket, and has also recommended the incorporation of regional reserve currencies within the new multi-currency basket.
Still, what is of greatest salience today is the need to lower the variability of currencies, or SDR-like units of account. Only then can economies plan for the medium term while currencies also function as a store of value. Secondly, by now there is considerable literature on the functional characteristics of common currency areas?and the consensus is that barriers to commodity trade and capital should disappear first.
That is of piece with China?s suggestion about marshalling more base-currencies into the SDR?s makeup ? one of the intents for doing that being to bring about a greater spread. That would be just the right insurance againt the bullying tactics (or lax monetarism) of individual governments just because they can better back their legal tender. In sum, greater diversification in the composition of the SDR would render it much less susceptible to economic air-pockets. Greater diversification would also balance out contradictory developments across countries ? including differences in policy stances, growth rates, or the accumulation of forex.
Destination-wise too, diversification is a must ?and Brazil?s is one of the best recent examples of how economic policy can be hijacked by overdependence on a limited number of countries. It had been growing at 6% even after the onset of the subprime crisis, and even succeeded in maintaining the rate right until Q3, 2008. But precisely that was its undoing!
Domestic levels of investment and consumption went into overdrive and?and persisted thus even after the manufacturing sector had been scared into production cutbacks! So, altogether too much of the additional demand spilled over into imports which, in the face of a global decline in international import demand, translated into a crash weight-loss course for Brazil?s trade surplus.
Finally, it is encouraging that increasing numbers of professional economists seem agreed that a currency union between countries at different levels of development actually dampens, and dissipates, the force of business cycles instead of magnifying them. That is quite unlike currency unions between ??similar?? economies (such as the Ecu-bloc, and today?s euro member states). Countries in all such unions have very similar and well-integrated economies?which also seem to explain why they enter and exit business peaks and troughs roughly together.
About the only unworkable thing about China?s suggestion is the manner in which politically, and historically, economies at differing stages of institutional development would manage to iron out dissimilarities so as to maintain convergent monetary policies vis-?-vis the world. The 16 EU member states which belong to the euro-bloc coordinate their policies with legerdemain; but, politically, they are not at all dissimilar. Besides which, their unwavering focus is on convergence.
But assume just for the moment that convergence is attainable?just as the transition to markets from ?socialistic pattern of society? has been! That yields a good idea why India has joined the Bric?not to lobby for an Asian SDR, but for a hike in IMF quotas. And, the reason why it wants to see an extra hike in the IMF?s equity (to $975 billion) is plainly because higher purchases from that corpus would enable it to fuel domestic demand-led growth without being accused either of lowering taxes or interest rates unduly, or ratcheting up fiscal deficits.
That is very unlike China, which has the money but wants a better repository in which to lodge its forex surpluses. The Indian story points to the wish for a ?friendly? banker who however is above suspicion. Little wonder that India pleaded for a 200% hike in the IMF?s quota. That would enable the erstwhile supply-sider to help in extricating economies out of their demand-side crisis!
As for the official version, the Indian Prime Minister is on record as having declared in March that India ?does not need IMF funding?, despite which it favours ?expanding IMF resources as this will help developing countries that need assistance. It will restore confidence about emerging markets.?
The author is a fellow at the Maulana Abul Kalam Azad Institute of Asian Studies, Kolkata. These are his personal views