March 24, 2009

China calls for Global Currency

POLITICS - China is calling for a new global currency controlled by the International Monetary Fund, stepping up pressure for changes to the global financial system dominated by the weakening United States dollar and western governments.

In an essay by the Chinese central bank governor released late Monday, the concept reflects China's growing assertiveness in economic affairs and its massive buildup of foreign reserves, mainly U.S. dollars, as well as its ownership of 50% of the US National Debt.

China is also pressing for developing countries to have a bigger say in finance when leaders of the Group of 20 major economies meet April 2nd in London to discuss the global credit crisis.

Gov. Zhou Xiaochuan's essay did not mention the US dollar by name but it said the crisis showed the dangers of relying on a single country's currency for international payments.

In an unusual step, the essay was published in both Chinese and English, making clear it was meant for an international audience.

"The crisis called again for creative reform of the existing international monetary system towards an international reserve currency," Zhou wrote.

Zhou said the proposed new currency should be used for trade, investment, pricing commodities and corporate bookkeeping.

The Chinese government has long been uneasy about relying on the U.S. dollar for the bulk of its trade and to store foreign reserves. Premier Wen Jiabao publicly appealed to Washington earlier this month to avoid any steps in response to the crisis that might erode the value of the dollar and China's estimated $1 trillion holdings in Treasuries and almost $6 trillion in U.S. government debt.

China is worried that the worth of its holdings of U.S. dollars could erode if the greenback falls in value against other currencies over the next few years.

The proposed new global currency should be based on shares in the IMF held by its 185 member countries, known as special drawing rights, or SDRs. The Washington-based IMF advises governments on economic policy and lends money to help with financial problems. Currently the money lent is based in US dollars, giving the United States an unfair advantage and inflates the value of the dollar.

Some economists have suggested creating a new reserve currency to reduce reliance on the dollar but acknowledge it would face major obstacles. It would require acceptance from countries that have long used the dollar and hold huge stockpiles of the U.S. currency.

There is also concerns about the security of the US dollar, which is notoriously easy to counterfeit because it has no anti-counterfeiting measures built into the bills. The US government has discussed creating a more secure currency but previous administrations have ignored the counterfeiting problem.

"There has been for decades talk about creating an international reserve currency and it has never really progressed," says Michael Pettis, a finance professor at Peking University's Guanghua School of Management.

Managing such a currency would require balancing the contradictory needs of countries with high and low growth or with trade surpluses or deficits, Pettis said. He said the 16 European countries that use the Euro have faced "huge difficulties" in managing monetary policy even though their economies are similar.

The benefits of having a single currency would allow companies to trade liquidity and cut out the banks as the middle man during exchange rates (banks typically take about 1% to 2% in profit from each exchange, but those nickles and dimes add up when you are exchanging billions of dollars per day).

Representatives from American and British banks say they will oppose the new currency, saying it would cut into their profit margins.

Zhou also called for changing how SDRs are valued. Currently, they are based on the value of four currencies – the dollar, euro, yen and British pound.

"The basket of currencies forming the basis for SDR valuation should be expanded to include currencies of all major economies," Zhou wrote. "The allocation of the SDR can be shifted from a purely calculation-based system to one backed by real assets, such as a reserve pool, to further boost market confidence in its value."

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