One thing that has come out of the financial crisis is a new world economic order. Or so at least the many people who dislike America are hoping for. They are still angry about George W Bush, if not the very existence of the US itself.
Visceral anti-Americanism is one of the few things that remain to unite the Left so there is much cheer in midst of the gloom. If capitalism is not to collapse in their lifetime, people wish at least the American hegemony would end.
Many analysts are predicting that economic power will pass from the US to China, from the West to the East. The dollar will decline as a key currency and a multilateral economic and financial order will emerge.
But the consequences of success are as difficult for the winner as for the loser. Thus, dollar can only lose its pivotal position in the reserves of most countries if there are other currencies to take their place.
Euro is one such candidate currency but the problem with the euro is that unlike in the case of dollar T-bills, there is no EU authority which issues eurobonds which countries can keep in their reserves. So countries have to buy German or French or worse yet Greek and Italian bonds if they wish to have euro.
The EU itself has a budget which is only 1.27% of its GDP. It also has a strict budgetary rule so deficit spending is not allowed at the EU level. So the supply of EU eurobonds is nil.
China has the same problem. The renminbi is not fully convertible and foreigners do not have full freedom to buy and sell Chinese assets. The Central Bank of China has offered Rmb swaps but no full convertibility. Indeed, since last year it has also stopped the Rmb floating against the dollar and gone back to pegging.
This is to preserve the value of its multi-trillion holdings of dollar assets. As Keynes said if you owe your bank a thousand pounds you spend a sleepless night but if you owe them a million they spend the sleepless night. The Chinese may be powerful but they are terrified about the collapse of the dollar.
The pound sterling was the key currency through the 19th century and up to 1914. It was based on the Gold Standard. So the pound was universally acceptable. But then it took 30 years till 1945 and two wars before the pound conceded the key position to the dollar. The Americans were eager to take over and willing to take up the responsibility of a hegemon. Neither China nor EU is ready to take on these responsibilities. The main task is to preserve the value of your currency even as others are depreciating, ie let your currency float up. This is painful for your exports and so most countries prefer to peg or have a dirty float as a protectionist device to help their exports.
A hegemon must also be ready to have free flows of capital in and out. This is why other countries will hold its currency in their reserves. If the country wants imports of capital but balks at capital outflow then it does not attract other countries? demand for its currency. There is no candidate for such policies as of now except the US.
But that still leaves the problem of the fragility of an international payments system which depends on the vagaries of the public finances of one country?the US. At least UK had the Gold Standard which permitted zero deficits for its budget through the period it was a hegemon. American currency?s value is never a constant but depends on the productivity of its labour and capital. If the US is to decline, one way to ease the pain is to let the dollar depreciate. But then it may export inflation around the world.
Of course, the IMF should have the capacity to step in to provide a multi-currency denominated asset. The SDR is one such asset, but it is not a means of payment, only a unit of account and a precarious store of wealth. The IMF needs to issue a better class of SDR which can be used in trade settlement.
This would require some international agreement to provide it with reserves in strong currencies. The G-20 in April 2009 resolved to let IMF have $500 billion but there has been no follow up in terms of contributions except $ 50 billion by the Chinese. We need more action by the rest of the world.
This will be the slow but sure way out. It will take perhaps a decade or more before the super SDR is in place but that is the sort of pace at which millennial events take shape.
?The author is a prominent economist and Labour peer