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Threat to Dollar as Global Reserve Currency is Real

By Hans Parisis
Monday, 27 Apr 2009 11:47 AM Current | Bio | Archive

Jean-Claude Trichet, president of the European Central Bank, said on the occasion of the G7 meeting in Washington: "We remain very cautious. We do not say things are going much better. … We are right to be somewhat encouraged, but we would be wrong to conclude that we are close to emerging from the darkness that descended on the global economy early last fall.”

On the Treasury’s bank stress tests, Trichet said this: “The leverage ratio computation seems to be based on U.S. concepts, accounting rules are not the same on both sides of the Atlantic. We may have a methodological bias. … We have to look at it very carefully."

U.S. Treasury Secretary Geithner said: "In the United States we want to have a recovery built not on a new hope of increased leverage and unsustainable levels of spending, but a more balanced kind of recovery in the United States. … Internationally, as a complement to that, we want to see a more balanced pattern of growth, thus the reference to domestic demand-led growth. I think if you look at the actions taken by a number of major economies you'll see the embrace of that basic objective."

Financial Stability Board (FSB) Chairman Mario Draghi said: "There are signs of gradual stabilization in the global economy. ... Certain spreads are going down, volatility is decreasing ... (to) pre-Lehman levels … in financial markets. … But we have still to break the vicious circle between the real economy and the financial sector. This is why I am cautious."

Also, according to Trichet, G7 finance ministers and central bankers at their Washington meeting on Friday have not felt the need to discuss China’s proposal to expand the use of the International Monetary Fund (IMF) Special Drawing Rights (SDR) as a reserve currency.

Notwithstanding, the G24 is seeing things rather differently. The G24, which is a grouping of emerging and developing countries from Asia, Africa, and Latin America, made it clear that they believed the proposal was worth a closer look and called on Beijing to provide more details.

Adib Mayaleh, the G24 chairman and Syria’s Central Bank Governor, said through a translator: "There are many countries that have started seeking another currency than the dollar."

China has argued that a super-sovereign reserve currency would eliminate the risks inherent in currencies such as the dollar and also make it possible to manage global liquidity. The IMF has said the idea is worth discussing but has repeated that the dollar's status is not under threat.

This weekend we have seen the reserve currency debate move on from the purely theoretical towards something rather more tangible as the BRIC nations (Brazil, Russia, India, and China) met to establish a common position on the terms they want to see from the IMF on its proposed first bond offering.

Interestingly, this bond will likely be denominated in SDRs but could also be sold in tranches according to the actual composition of the SDR with the four currencies (USD 44 percent, EUR 34 percent, JPY 11 percent, and GBP 11 percent) in the basket.

For the time being, the key questions now center on:

  • The maturity of the IMF bonds

  • Will there be a secondary market for these IMF bonds?

  • Will the IMF bonds qualify as government reserves? (This is extremely important!)

    The IMF’s initial proposal for the bonds was, according to Dow Jones newswires, rejected by the BRIC nations as they felt that the maturity on offer was too long.

    As part of their campaign to increase their voice within the IMF, they wish to retain as much of their bargaining power as possible ahead of the wholesale reform of quotas that should increase in January 2011, whereby voting shares increases for China go to 3.8 percent (from 0.9 percent); and Brazil to 1.7 percent (from 0.3 percent).

    It is important to note that China (No. 3 in global GDP in 2008, according to IMF’s ranking) will have voting rights similar to the Netherlands (No. 16) and Belgium (No. 20).

    The BRIC countries have also made it clear that they would prefer paper with a maturity of around one year, which is not in common use. They also apparently made it clear that they do want the bonds to qualify as government reserves and that they should be tradable on the secondary market, so they can be liquidated easily should the need arise.

    Finally, the yield, according to Brazilian Finance Minister Guido Mantega. "can't be very much different from U.S. Treasury bonds, maybe just a little more." According to reports, negotiations surrounding this first bond issue could be wrapped up over the course of the next week.

    In my opinion, investors shouldn’t make the error of putting the time horizon for their investments beyond 12 months, albeit for fundamentally different reasons than the BRIC countries. They should certainly not lock in any longer term investments for the moment. I would still remain extremely cautious and remain focused on the “keeping what you have” strategy.

    Be sure, better times are still not here yet. Later this year we could see some “less-worse” GDP numbers thanks to the enormous stimulus injections. But, nobody knows if the actual, massive medicine will be sufficient to save the patient.

    Coming back to the BRICs, we see the amounts under discussion as relatively small. Brazilian Finance Minister Guido Mantega made it clear to The Wall Street Journal that Brazil plans to buy the bonds while Russian Finance Minister Alexei Kudrin said Moscow would be a purchaser as well, although he also didn't name an amount.

    China is also expected to buy around $40 billion of the bonds. Nevertheless, this would represent a first tentative step on the road towards their long-term goal of more effective reserve diversification.

    Given that emerging and developing economies account for 72 percent of the growth seen in forex reserves over the course of this decade, the importance of the comments from the G24 chairman over the weekend should not be underestimated. Therefore, while the IMF may believe that the dollar’s status as the premier reserve currency is not under threat, it is easy enough to believe that these latest developments constitute a potential negative for the dollar in the longer term.

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    Jean-Claude Trichet, president of the European Central Bank, said on the occasion of the G7 meeting in Washington: "We remain very cautious. We do not say things are going much better. … We are right to be somewhat encouraged, but we would be wrong to conclude that we are...
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