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Doug Saunders

Dislodging the dollar won't be easy Add to ...

The foundations of the world are shifting. The U.S. dollar, which forms the bedrock of three-quarters of all national budgets, the medium of 86 per cent of all financial transactions and the reference point for two-thirds of the world's currencies, is beginning to crumble.

Those who expect it to be replaced soon, though, will be disappointed: However much it is resented and distrusted by the countries forced to hold it by the trillions, however much it devalues and fluctuates, however unfair and biased it seems, the greenback will not be so easy to dislodge. We know this, because so many people are trying hard to dislodge it.

At some point before Canada hosts the G20 summit of major economies in June, China will announce that it wants the world to abandon the U.S. dollar as its main reserve currency. This, Chinese officials will declare with the backing of Russians and the major Persian Gulf oil states, should be the major topic of the summit.

I can say this with some confidence because this is exactly what Chinese officials declared in advance of last year's G8 summit in L'Aquila, Italy, the G20 summits in Pittsburgh and London and the meeting of the International Monetary Fund in Istanbul. A resolution to replace the dollar as the world's reserve currency has been promised, over and over. And it has never been delivered.

China would very much like to end the dollar's dominance. At first, this desire was simply political, as Asian leaders don't like to see the United States earning tens of billions every year simply off people holding greenbacks in their savings. But there's now a more panicky practical reason: If America devalues its dollar by a third, as many expect, China's $2-trillion in cash reserves, almost all of it dollars, will lose a vast amount of value.

The problem, until now, is that there has been nothing to replace the dollar. Other world currencies were locked into one country's economy and pegged to the dollar (China's yuan), or too unstable (Russia's ruble), or lacking in a centrally issued debt instrument like the U.S. Treasury bill for storing reserves (the euro).

On Wednesday morning, I attended an exercise in trying to break this deadlock. Economists from the International Monetary Fund, London's Chatham House and several major banks launched a proposal to rebuild the world's monetary system. Two Chinese economists participated, and their government watched closely.

It would adopt, as its main anchor, the rather obscure "currency" known as Special Drawing Rights (SDRs), used by the IMF to denominate the loans it uses to bail out bankrupt countries such as Ukraine, Hungary and possibly, soon, Greece. Based on a basket of major currencies, this unit has the strength of being very stable and nationless. It has the weakness of being impossible to spend.

But that may be changing. Last year, the major oil economies of OPEC - a broadly anti-American bunch - began discussing a plan to start denominating international petroleum sales in SDRs rather than dollars. China participated, as its government would very much like countries to start paying accounts for Chinese goods in SDRs, or yuan, or anything but dollars.

So the economists proposed a system where SDR-denominated oil sales wouldn't have to be converted immediately into local currencies; instead, there'd be SDR-denominated financial institutions, central banks and so on. Since the IMF happens to be bailing out a lot of economies these days, there'd be a lot of this odd currency floating around, anyway, so why not make it everyone's favourite price tag?

That sounds good on paper - a bit like Esperanto, it's an ideal international solution that is never actually going to happen. The problem, as Goldman Sachs economist Jim O'Neill said, is that the existing monetary system is actually working pretty well. The devaluation of the dollar is actually forcing China to start creating consumer demand within its own huge economy, rather than relying on reserves, and the euro and the pound are holding up reasonably well, too.

Mr. O'Neill should know: He was the one who identified Brazil, Russia, India and China (the BRICs) as emerging economic leaders a decade ago. He now says the dollar will likely be supplanted, in these countries, by other currencies by the end of this decade. It just isn't going to happen suddenly because someone declares it.

A more quiet revolution is taking place. When its history is told, its epoch-defining moment may have occurred in January, when the Harper government issued a $2-billion bond denominated, for the first time, not in dollars but in euros. As Finance Minister Jim Flaherty explained to investors here this week, it wasn't done to raise money but to diversify Canada's cash holdings away from the dollar. In a thousand slow, subtle gestures like this one, the dollar may gradually withdraw from the scene.

 

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