The current call for a global currency is not a new one. In the past and especially when the dollar showed signs of weakness, there have been calls for replacing dollars. This article tries to look at the reasons why the earlier moves didn�t materialize and the future prospects. IMF introduced Special Drawing Rights (SDRs) in order to supplement USD and gold as reserve currencies to solve the liquidity problem. Triffin�s dilemma showed that the US would have to continually run a current account deficit to provide the global liquidity. After floating exchange rates came into being the worry about global liquidity evaporated and hence the SDRs never really served the purpose they were intended to. But there were many attempts to popularize the use of SDRs as it was believed to be a much superior alternative. Later in 1970�s when dollar showed consistent weakness, it was also believed that the SDRs could provide an effective diversification by replacing portions of USD reserves. At that time the USD accounted for roughly around 70 percent of non-gold reserves. The way to go forward was by creation of a substitution account. The most comprehensive proposal on creation of a substitution account was the Polak-de Larsosiere proposal. This proposal may not have worked towards a potential solutions because- First the US was not sure about the interest cost to be paid after its short term liabilities to central banks were converted into long term liabilities to the fund. One of the ways to overcome this was to sell a portion of IMF gold- which could be used to cover the transition cost.   If IMF along with other countries like China who hold huge reserves agreed to compensate some portion of US loss then this problem could have been overcome. Second, many countries were not willing to accept a lower interest rate that the SDR would pay against a much higher rate paid by the US treasury. This really wasn�t a serious problem retrospectively, because for a very long period of time the interest on SDR was higher than the US treasury rates. Thirdly as the SDR is a derivative index of currencies with the dollar having the highest weight age, an expansionary policy on the part of the US would lead to depreciation of dollars and softening of short term interest rates. This created an uncertainty about the viability of future interest rates which could be paid on the SDRs. The way forward to solve this problem would be to diversify the SDR to a much larger basket of currencies. The current weighting system which gives weight as per the trade denominated among the four currencies needs to change. A new formula will have to be found.
Similar to the situation in 70�s, even in present times most of the global reserves are denominated in the US currency (fig 1). Roughly 65 percent of currency reserves are held in USD (used Brad Setser�s calculation). While in the 1980�s the developing (developing and emerging are used interchangeably) nations didn�t have much reserves and are only interested in getting the funding. The ratio of non-gold reserves held by advanced economies and developing economies is at the lowest. This can be interpreted as the change in the reserve accumulation shifting from advanced economies to emerging economies. The global non-gold reserves index has also picked up after 1998 when the East Asian economies started building huge reserves (fig 2). So, this time the lead is taken by the emerging economies.
Fig.1: Composition of foreign exchange reserves.
Source: Brad Setser, CFR
Fig 2: Non-Gold Reserves
Source: IFS, author�s calculation
The solutions mentioned here are not new as the debate is not new itself. The timing is as good as it will ever get. We have the benefit of hindsight and willingness of many more countries to accept the change. Many believe that the root of the current crisis is the dollar hegemony. It serves the reserves holder as well as the US in the long run. The current step taken by the G20 to empower IMF is a positive one. But much more needs to be done – a strong political will and to move away from the thinking of currency as a source of sovereign identity.