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Economy Lab

World Bank makes case for new reserve currency Add to ...

It’s easy to dismiss French President Nicolas Sarkozy’s pledge to use his term as chairman of the Group of 20 to talk about overhauling the international monetary system as quixotic, a distraction from the more pressing problems related Europe’s sovereign debt crisis, or even a waste of time.







The World Bank is taking a different view.







Those who bothered to read to the end of the Washington-based institution’s 30-page economic outlook this week stumbled on perhaps the clearest reasoning yet for why Mr. Sarkozy is right to begin discussing whether the world needs a new reserve currency.







“To date the dollar remains and is likely to remain for a long time the dominant reserve currency in the global economy,” the says the report, which was written by an economics department led by chief economist Justin Lin. “In the long-run a gradual move toward reliance on new or additional currencies is both likely and desirable.”







The World Bank was moved to this position by the events of last year. The decision of the Federal Reserve to adopt “very loose monetary policy and the depreciation of the dollar may be having impacts on global confidence in the dollar as the international reserve currency, which could have important consequences.”







The World Bank adds in the report that the situation is exacerbated by Europe’s debt woes, which undermines confidence in the euro. Its economists note that over the past several years, the values of the dollar and the euro have oscillated “a great deal, potentially reducing their qualities as a stable store of value that partly explains their use as international currencies.”







For those who wonder why any of this matters, the World Bank points out that both the abandonment of the gold standard during the Great Depression and the collapse of the Bretton Woods system in the 1970s were associated with extended periods of slow economic growth. In other words, there might be a correlation between stability in the international monetary system and a healthy global economy.







Mr. Sarkozy, who flew to Washington earlier this week to talk about his plans for the G20 with President Barack Obama, has stressed that his not seeking to undermine the dollar. Rather, the French president says he simply wants to have a discussion to explore ways to calm increasing volatility in foreign-exchange markets.







China is on board and will host a conference on the subject under the G20 banner later this year. Canada, judging by Finance Minister Jim Flaherty’s answer to a question about the possibility of a new reserve currency earlier this week, is opposed.







The G20’s immediate priority should be dealing with the “potential dangers in Europe,” Mr. Flaherty said after a speech in Washington. “The American dollar is serving the purpose” of reserve currency, Mr. Flaherty said.







Mr. Lin’s World Bank economists are less certain. While they agree it’s unlikely, they refuse to rule out the possibility that the dollar and the euro could “cease anchoring” the international monetary system over the medium term. “This could give rise to a further bout of protectionism and disruptive exchange rate volatility, with damaging effects for global growth and poverty reduction.”





 

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