The International Monetary system is passing through a historic change after the collapse of Bretton Woods system. The Bretton Woods system marks a historic milestone for a national currency (US Dollar) to serve as the global reserve currency for such long period. Reserve currency is a currency held by central banks and other major financial institutions as a means to pay off international debt obligation or to influence the domestic exchange rate. The US dollar serves as an international reserve currency mainly due to the size of its economy and large liquid dollar-denominated bond market.
TRIFFIN DILEMMA
However, in recent decades, serious questions have been raised among policymakers over the sustainability of a national currency to serve as global reserve currency. Those concerns are primarily due to persistent current account deficit and large foreign debt held by the United States. Robert Triffin had rightly mentioned those problems five decades ago. According to Triffin "A national currency which also serves as global reserve currency always have to maintain a current account deficit". In simple words, the country whose currency a foreign nation wishes to hold must be willing to provide an extra supply of its currency to the world. This extra supply of national currency fulfils the demand of reserve currency and may result in a trade deficit.
The Triffin's Dilemma argued that the demand for an international reserve currency means that excess supply will undermine its value. Countries like China and Russia which are enormous dollar dominated debt holders are understandably frustrated by a lack of alternative reserve instruments. They are also worried about the value of their hoard's in case the USA defaults on its debt obligations. More so they are aspiring for power that's makes no secret of Washington global hegemony and bat's for more equitable world order. The solutions, however, don't lie in replacing the dollar with other national currency. But moving towards a multi-currency system and make greater use of only true global currency I,e. " Special Drawing Rights ". There is a fundamental incompatibility between the attainments of Global Economic Stability and having a single Currency performing the Role of the World Reserve Currency. The underlying conflicts identified by the Triffin Dilemma always remained. The ease with which the US could borrow and carry debt was tolerated for decades. No doubt such tolerance was due to gold no longer being a monetary anchor. But in 2007 it reached a point where it could no longer be tolerated. Not because investor decides to be present but because market structure could no longer cope with more debt.
SPECIAL DRAWING RIGHTS : The Road Ahead
Robert Mundell once said " Great Power have Great Currencies "
US with its $19trillion Dollar debt obligations and almost an average zero percent growth for the past one Decades. It ' s no longer be a Great Economic Power in the near Future and so does Currencies. With Major Debt bubbles in form of Real estate, Bond , Stocks and Derivatives looming across the major Global Economies like US , Japan ,EU and China. The apprehension among policy maker is that US dollar will be no longer able to Provide enough liquidity or act as anchor if next Economic crisis happens. Since Dollar lost all its firepower in battling the recession in 2008 Cause due to US Housing Bubble Collapse in form of Quantitative Easing. So the only way forward is to look for another Currency which act as source of major liquidity in Case of any Crisis.
SDR was created by IMF in 1969 as a supplementary reserve asset in the context of Bretton wood system. Since gold and dollar proved inadequate for supporting the expansion of world trade as well as financial flows that were taking place. SDR's have never been alien to world monetary system and were issued to increase the global liquidity during major International Crisis. Whether in 1971 oil crisis or 1997 Asian financial crisis as well as recently in 2009 during " US housing bubble " collapse. Initially, the value of SDR was defined as 0.888671 grams of gold which at that time also equivalent to one US dollar. After the collapse of Bretton Wood system the SDR was redefined as a basket of currencies. The basket consist of US dollar, euro, Japanese Yen and Pound Sterling. The membership in the SDR basket gave a symbolic IMF approval to hold these currency as a reserve instruments for foreign government. In recent months The IMF executive board has decided to increase the role of " SDR" in the global financial architecture. In November last year , the IMF took decision to include Chinese currency "Yuan " in its special drawing rights basket as fifth currency effective from October 1 this year. The decision marks an important milestone in the integration of Chinese economy into global financial system as well as it could been seen as a vote of confidence in China growing financial clout. The G20 Summit in China in September has added more impetus to this Shift . When the Policy Makers decided to increase the role of SDR in Global Monetary System in order to avoid the Crisis. It has been agreed that the SDR will replace the dollar to settle trade from October. Later this year Countries will be able to exchange the dollar and Treasuries for SDR from the IMF. China and IMF have been pushing the idea of creation of SDR-denominated bond market from a long time. The idea comes to the realisations this month when World Bank decided to issue a 2.8billion$ SDR bond in China domestic market. Thus fulfilling one of the prerequisites to become a reserve currency. Remenbi will be included in SDR basket as a fifth currency along with US dollar/ japanese yen and the British Pound. Remenbi will have a weightage of 10.92 percent in the new sdr basket , while weighting of other Currencies in the basket are 41.73 percent for the US dollar , 30.93 % for Euro , 8.33% of Japanese yen & 8.09 % for British Pound . The process is quite slow as no one wants the dollar or treasuries to collapse soon as this would have a very negative impact on Global Trade. SDR bonds will not compete with dollar-denominated bond market anytime soon but the ground work is being laid. As Confucius Said " A journey of thousand miles begins with a single Step". .