Dollar Dazed

One of the debates coming out of the global financial crisis is the potential for the U.S. Dollar to loose its supremacy as the safe-haven and international reserve currency of choice.  The dollar has not experienced this kind of problem since the 1970s when U.S. inflation threatened the Bretton Woods agreement.  The threat to the dollar’s supremacy is based on different issues this time around. The first issue is the pervasive and increasingly huge U.S. trade deficit which  has contributed to huge dollar holdings in oil rich countries and China.  The second issue is the widespread acceptance and credibility of the Eurodollar.

Prior to the GS 2- meeting, China called for replacement of the U.S. Dollar by Special Drawing Rights (SDR) as the international reserve currency.  This would certainly diminish U.S. economic influence around the world.  What is an SDR and what is the chance it will supplant the Dollar as the currency of choice in the global economy?  The best place to learn about Special Drawing Rights is to go straight to  the IMF website.

The SDR is an international reserve asset, created by the IMF in 1969 to supplement the existing official reserves of member countries. SDRs are allocated to member countries in proportion to their IMF quotas. The SDR also serves as the unit of account of the IMF and some other international organizations. Its value is based on a basket of key international currencies.

As you can see, SDRs have been around for some time. They were created during the inflationary period of US history to support the Bretton Woods Agreement.  This agreement established a fixed exchange rate regime to help build the global economy as it was experiencing World War 2.  Bretton Woods is a small town in New Hampshire and served as the meeting place for the representatives of the 44 Allied Nations.  This agreement was the basis of international currency evaluation until it’s official demise in 1976  in Jamaica.  The system had collapsed prior to that date so the Jamaican agreement was really just an ex poste meeting to officiate the end.

Since then, most of the world’s currencies are traded on markets and the market determines their exchange rates.  This is called a flexible exchange rate regime.  Not all countries have flexible exchange rates.  Some countries (because of weak governments or problems with inflation) peg their currencies to a stronger currency in their geographic area.  Other countries adopt the currency of their economically stronger neighbors.  Some form currency unions where they share a common currency.  The biggest of these unions is the Eurozone which remains a coalition of politically independent countries that rely on the Eurodollar for trade.  Both the Wikki site I referenced above as well as the International Monetary Fund site have some really interesting historical backgrounds and are worth the read.  I’ve read through the Wikki reference and can guarantee that information on it is correct so that I do not have to send you to a textbook or someplace more complex.  (International Trade, Finance, and Macroeconomics are my primary research areas now.  I’ve somewhat branched out from my first masters area which was just basically the Financial economy of the U.S. and it’s the subject of my dissertation.)

The SDR is the unit of account for the IMF and other international development funds. It’s not really a currency or a money as we tend to think of monies today.  This is because it is not a claim on the IMF in the way that a dollar bill is a claim on the Federal Reserve Bank and essentially the U.S. Treasury.  It is a potential claim on the set of currencies that it represents.  These currencies are basically those of the IMF members and they are placed in what is known as a basket.  The basket is a weighted average of all the currencies of the members. This is how SDRs are ‘created’ (also from the IMF link.)  Today the basket consists of the yen, the Eurodollar, the U.S. dollar, and the U.K. pound sterling.

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