Published March 27, 2009

US$ dodges the bullet - but still under fire

Geithner's remark stokes debate on its status as world's main reserve currency

By LARRY WEE

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(SINGAPORE) The US dollar's status as the world's main reserve currency came into sharp focus when a casual remark by US Treasury Secretary Tim Geithner on Wednesday briefly sent the greenback tumbling.

Despite calls for a new reserve currency, few realistically believe that the US will agree to any move that could lead to a major devaluation of the US dollar.

China has been calling for a new reserve currency and an overhaul of the global monetary system. It wants a larger role for Special Drawing Rights (SDRs) - a synthetic currency maintained by the International Monetary Fund (IMF) that represents a basket of actual currencies - as a possible alternative to the US dollar as the world's main reserve currency.

Asked about a proposal from China's central bank governor Zhou Xiaochuan for expanding the role of SDRs, Mr Geithner said: 'We are actually quite open to that.'

The dollar slid as much as 1.3 per cent against the euro within 10 minutes of news accounts of Mr Geithner's remarks. Headlines saying 'Geithner open to SDR currency' flashed across traders' screens - which they interpreted to mean that he was willing to discuss reducing the role of the US dollar on the global stage.

The interviewer then gave Mr Geithner a chance to 'clarify' his remarks and the Treasury secretary firmly stated that the US dollar would remain the world's dominant reserve currency. This helped the greenback climb back.

The euro, for example, was widely reported to have surged to a US$1.3650 high after Mr Geithner's original remark on the SDR was quoted, only to fall back more than one US cent in the next hour. Yesterday, it finished Asian trading comfortably below US$1.36.

The issue of an alternative reserve currency is a touchy one. 'A move to an SDR-linked system away from the dollar would naturally lead to a reduction in the dollar's share of global reserves,' strategist Lee Hardman at Bank of Tokyo-Mitsubishi Ltd wrote in a note.

China is the largest foreign holder of US Treasuries, and Premier Wen Jiabao earlier this month expressed concern about the value of its investment.

There is growing pressure on the US dollar to weaken from other directions as well, among them the large quantitative easing measures announced by the US Federal Reserve last week, which could have the effect of pumping up to US$1.15 trillion worth of new funds into the domestic US banking system before the end of 2009. Responding to that announcement last week, Royal Bank of Scotland's (RBS) head of research Alan Ruskin warned: 'In this regard, the psychological impact should not be underestimated. This is an historic moment - the start of debasement of the world's reserve currency.'

The push for an alternative to the US dollar as a reliable store of value is unlikely to go away anytime soon, from large trading nations such as China and Russia to Middle East oil producers whose revenues are still largely received in the greenback, and even hedge fund luminaries like George Soros.

For example, Mr Zhou has reportedly been raising various other options for discussion as well, such as a Keynesian-based approach - one which argues that the value of an international reserve currency should more correctly be based on a basket of 30 commodities.

But few realistically believe that the US will agree to any move that could lead to a major devaluation of its currency.

Standard Chartered Bank researchers said yesterday: 'Being in a position to print pieces of paper that other countries accept readily is a hard one to give up.

'However, the fact is that this allowed the US to live beyond its means for too long, arguably helping to contribute to the current global crisis. Whether or not the debate does progress, it is clear that China for one is stepping up its pressure on this issue.'

A move towards SDRs could have implications for China, too.

SDRs currently have four currency components - the US dollar, euro, Japanese yen and British pound. UK-based research firm Forecast explained that a correctly-constituted SDR should now include the yuan as an important component, given China's fast-rising importance as a global trade partner. However, the yuan's inclusion would also carry implications that China may not be willing to tackle quite so soon. Among others, 'it also means seeing a dramatically higher exchange rate and dramatically lower surplus', Forecast wrote.