Over-reliance on US dollar

To get the imbalanced world economy onto a balanced track international monetary system needs reform

There are two sharply contrasting arguments to explain the global imbalances between the United States as the biggest trade deficit country and China as the biggest trade surplus country.

The first argument blames China as the major source of the imbalances, while the other seeks more fundamental reasons within the international monetary system (IMS) itself.

In fact, both arguments are two sides of the same coin. On the one side, the world economy is based on the US dollar, and the US dollar has always been regarded as a “public bus”, providing a “free ride” to other currencies.

Apart from the network externality value to the US of widespread dollar usage, such a position also has an obvious economic advantage, known as “seigniorage”. In return for injecting liquidity into world trade and investment, the US government, in exchange, receives goods and services from other countries.

Seigniorage can be realized only under two conditions: One is that the currency must be international; the other is that the issuer must be a sole or dominant importer.

In the past six-plus decades, the US dollar has played a pivotal role as catalyst for the post-war international trade and economy, which has enjoyed the greatest rate of development ever known. Related readings:

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But as time has passed, the US dollar has been constantly injecting excessive liquidity into the world economic system. As a result, the US has accumulated a huge trade deficit, shared between 91 countries, among which China and Japan are the largest.

The US has fulfilled the two above-mentioned conditions for seignorage, despite possible conflicts of interest between short-term domestic and long-term international economic objectives – the so-called Triffin Dilemma, which was identified by Professor Robert Triffin in the late 1950s.

In 2009, Governor Zhou Xiaochuan of the People’s Bank of China raised the question of whether the world would benefit from a supra-national currency, ideally the International Monetary Fund (IMF) Special Drawing Right, to avoid the risks of the Triffin Dilemma.

However, there is no certainty that this artificially created supra-national currency will ever come into being, so the practical issue confronting the world is this: If the creator of an international reserve currency cannot eliminate the Triffin Dilemma on its own, can the burden be shared with other emerging currencies, such as the Chinese renminbi, Brazilian real or Indian rupee, to make the global economy more balanced?

Such a choice should be based mainly on the economic and demographic weights of major IMS participants. For instance, the US’ share of the world economy amounts to about 23 percent, but the US dollar is widely used in 70 percent of world trade and 67 percent of international reserves. The euro comprises 26 percent of the world’s foreign exchange reserves, while the EU’s voting power in the IMF surpasses that of the US.

China is now the world’s second largest economy, and the top exporter, but its voting power in the IMF has barely climbed above the 4 percent level.

The IMS clearly needs readjustment.

But on the other side of the coin, China also needs to readjust its economic development scheme from an export-led strategy to a more consumption-oriented economy, in spite of its huge accumulation of foreign reserves, which are largely in US dollars. In order to better manage its foreign reserves, China should import more, and find alternative ways to invest offshore, other than putting its trade surplus back into US treasury bills.

In the years to come, China’s national currency should sooner or later be playing an international role in trade settlement and central banks’ deposits, in line with its economy going global.

This sounds like a solution to the Triffin Dilemma: If it cannot be totally eliminated, it can, at least, be shared by many others so as to get the imbalanced global economy back onto a more balanced track.

In March this year, G20 central bankers, top academic thinkers and financial leaders assembled in China to seek solutions to this question. Former IMF managing director Michel Camdessus formed an elite 18-member economist group from around the world to tackle the Triffin Dilemma.

The Nobel prize-winning Canadian economics professor, Robert Mundell, proposed the idea of establishing a world central bank, with a fixed exchange rate system and many others have provided their wisdom in developing this idea.

However, no consensus on reform of the IMS is yet in sight. We are, and will be for a long time to come, living in a predominantly US-dollar-denominated world economy that has generated imbalances in trade and the oversupply of liquidity.

The author is senior researcher at the China Center for International Economic Exchanges in Beijing.

(China Daily)

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