USA & China: Debate over Reserve Currency – A History of Dollar Era
A History of Dollar Era
After WWII, an agreement in 1944 created the Bretton Woods System. Under this financial system, all other currencies were pegged with US Dollar, which was linked to gold at the rate of $35 per ounce. Thus US Dollar became the key currency of the world. At that time, Dollar could not be over issued like today, because it was backed up by gold, and was thought to be as good as gold.
In 1970, the gold coverage of paper US Dollar dropped from 55% to 22%, because the US printed more Dollars to pay back its trade deficits. Foreign countries, such as Switzerland and France, lost faith in Dollar and began to trade their Dollar reserve into gold from the US. In order to stabilize the economy, President Nixon canceled the Bretton Woods System in 1971. After that, Dollar can no longer be convertible to gold directly.
In the following 30 years, after the collapse of fixed exchange rate under Bretton Woods System, most major countries in the world adopted floating exchange rates. But most international transactions are still dominated in Dollars; this maintains US Dollar as the De Facto world currency. The difference is that the circulation of Dollar is no longer restricted by the gold reserve. Comparing the price of gold at about 910 Dollars per ounce today, you can get a rough picture of it.
Post Dollar Era
As worried about Fed printing loads of money to respond the crisis, which may hurt China’s Dollar reserve, China realizes it can not rely too much on Dollar in the future. So China suggested substituting US Dollar with IMF’s Special Drawing Rights (SDRs) as the world’s single reserve currency in the future. SDRs, also called “paper gold”, were first created in 1969 as a tool to enhance the liquidity through replacing gold and silver in international transaction. The value of SDRs is determined by a basket of currencies include Dollar, Euro, Yen and Sterling. Although Dollar is still the key currency in this basket, its weight declined to 44 percent. In this way, other countries may be in a better place to defense their currency reserve when the key country suffers a bad time.
Whose Cheese Gets Moved?
See who said no. “I don’t believe that there is a need for a global currency. The dollar is extraordinarily strong right now”—this is Obama’s response to the proposal. There is no reason for the US to give up the Dollar’s reserve currency status right now. “Diluting Chinese savings to bail out America’s failing banks and bankrupt households, though highly beneficial to the US national interest in the short term, will destroy the dollar’s global status.”(Andy Xie, Financial Times May 4 2009) It is true, but only true in a long run.
It took over 10 years for Dollar overtaking Sterling as the world’s reserve currency after the US surpassed the UK in economy. It also took 15 years for Euro to be adopted after Euro Currency Unit first came to exist. It may take a long time for countries to recognize the SDRs. Before that, the SDRs should be further improved and perfected by IMF. However, don’t overlook that every major issue must get 85% votes in IMF, where the US owns 17% alone—enough a veto over every proposal. So, there is a still a long way to go. Even Governor Zhou Xiao chuan said, “It is a long term issue.”
