A week is a long time in politics. Last week, while the IMF meetings were going on, the talk was of devising an alternative reserve currency, of boosting the SDR and making it a viable multilateral currency itself. Gold has again appeared in international debates about currency reform, although the actions of consumers have been swifter in favour of gold than of the central banks.
But even before the IMF had met, the BRICS summit in Hainan had already begun to move the furniture around. The Chinese have been frustrated about being lectured at by the Americans about the revaluation of the RMB. They quite rightly feel that as one of the larger creditors of the US, they deserve some respect. Also, the QE policies, which the Fed has been pursuing, may be alright for the US economy but it is flooding the world with dollars, depreciating the currency and generating uncomfortable capital inflows for emerging economies. There is all the more reason therefore, the Chinese have concluded, that if the global authorities?IMF in particular?will not reform the system, the Chinese will have to do it themselves.
This is why the decision to have mutual trade facilities in the BRICS currencies is a crucial decision. When after the War there was a dollar shortage, the western European countries created a European Payments Union to conserve dollars by allowing bilateral trade in their as yet non-convertible currencies. Here we have potentially powerful currencies creating an alternative pool of currencies that can avoid the dollar. Soon, other countries will be clamouring to join this pool.
The Chinese authorities are also creating new RMB dealing centres. Hong Kong is already a market for RMB contracts and Singapore will be the next. This is China?s way of gradually getting the RMB to become a fully convertible currency. In a world of G2, the only viable alternative to the dollar will be the RMB unless, of course, SDR can become a much more used currency, both as a means of payment and a store of value.
China?s luck improved when another tectonic plate shifted earlier last week. When Standard & Poor?s (S&P) declared that they were posting a negative outlook on US debt, the global centre of gravity shifted. It was like a mild earthquake. The argument for the dollar as a global reserve currency has always been that Uncle Sam stands behind it with deep pockets, that it is a very liquid and a very deep market. Now comes along S&P throwing a wet blanket over the power of Uncle Sam. Of course, one could sneer and say that S&P having got so many rating calls wrong during the 2006-09 period, why should we trust its judgement. But anyone who has witnessed the goings-on in the US Congress and its battle with Obama will know that there is no credible strategy of debt reduction that either side has yet come up with.
What we have been entertained with are schemes of fantasy budget cuts, one from Congressman Ryan and the other from Obama. They are bargaining postures rather like the fake battles in TV wrestling contests when there is much grunting and grinding but little genuine fight. The US budget was in balance for about two years at the end of the Clinton presidency out of the 31 years since Reagan became President. Americans will tell you righteously that this is the way they provided the world with liquidity. But it is a free ride and a privilege where the US gets all the benefits and the world suffers from the zigzags of US fiscal deficits and trade imbalances.
The Bretton Woods system had the dollar as a reserve currency but there was a modicum of discipline on the US since it had to exchange surplus dollars for gold. Once Nixon reneged on the deal on August 15, 1971 (a day that will live in infamy), this mild constraint was removed. The dollar was convertible into the dollar and nothing else. The world is thus run on a fiat currency of a single government. Now S&P tells us that even this fiat currency may be lame because Uncle Sam does not have deep pockets.
The need to find an alternative or at least a supplement to the dollar has thus become quite urgent. As of now, the SDR is a joint liability of the entire IMF system and countries can cash SDRs for currencies of any of the four participating members?dollar, sterling, yen and euro. The countries issuing these currencies can honour all SDR liabilities if presented to them. But we need to augment the SDR by adding the 4 R?s?RMB, rupee, real and rouble. It may take some time but such a move to spread the risk would be the right one.
The world saw tectonic plates shift last week. Let us celebrate.
The author is a prominent economist and Labour peer