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Sarkozy sets stage for open season on the dollar

Those who grumbled that nothing of significance happened at the Group of 20 summit missed Nicolas Sarkozy's press conference. The French leader said he and Chinese President Hu Jintao have come up with a strategy that will ensure much of the next 12 months is spent questioning the U.S. dollar's role as the world's reserve currency.

Mr. Sarkozy, who took over the G20 presidency at the end of the Seoul meeting from Lee Myung-bak, didn't put it quite this way, of course. He started by repeating what he has been saying for a while: That his No. 1 agenda item will be an examination of the international monetary system. Then the new twist: Mr. Hu, who visited Mr. Sarkozy before the summit, had agreed to host a "seminar" on the subject under the G20 banner in the spring.

The symbolism of China hosting a major gathering to discuss currency policy is impossible to miss. In March, 2009, Zhou Xiaochuan, the governor of China's central bank, proposed replacing the dollar as the reserve currency with the Special Drawing Right, or SDR, a little-used unit of exchange run by the International Monetary Fund. (The IMF bases the SDR's value on a basket of the dollar, euro, pound and yen.) Mr. Zhou's suggestion created a stir as investors wondered if China was getting ready to abandon the dollar. Now, thanks to Mr. Sarkozy, Mr. Zhou will get to organize an entire conference on the subject with the world's currency traders watching in rapt attention. There will be fireworks.

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In Seoul, G20 leaders agreed to "build a more stable and resilient international monetary system," which Mr. Sarkozy presented as evidence that he's not alone in looking for a better way to organize global currency policy.

"Two years ago, people looked at us like we were weird," Mr. Sarkozy said, referring to the French government's criticism since the financial crisis of excessive volatility in foreign exchange markets. "Now the G20 is agreed that we have to improve our world order."

Many will scoff and sneer at all of this. Back when the smaller group of seven advanced economies was running the show, former officials will snidely say they had to put up with talk of overhauling the monetary order once every seven years when France's turn came to set the agenda.

Mr. Sarkozy likely won't recreate the talks held in Bretton Woods, New Hampshire, in 1944 that established a system of fixed exchange rates to the dollar, which was in turn pegged to gold. But it would be wrong to assume talk of changing the international monetary system will go away when Mr. Sarkozy's presidency does.

The U.S. system of government is proving incapable of delivering the sound economic policy necessary to ensure that the dollar's value remains stable. The biggest reason the Federal Reserve is proceeding with its dollar-weakening strategy of creating money to buy financial assets is because Congress is incapable of doing anything to address the country's unacceptably high unemployment rate. A critical mass of fast-growing economies is rightly asking why policy makers and politicians in Washington should have such an outsized role in determining the well-being of sovereign countries.

What is unclear is where all this will lead. The U.S. isn't going to give up the advantages of controlling the world's most used currency without a fight.

There will be lots of talk of creating a new reserve currency. World Bank president Robert Zoellick already has launched the first salvo, proposing last a week a SDR-like unit that would include the yuan in the reference basket and have some link to the price of gold. This talk tends to forget that businesses and individuals will ultimately have to agree to accept the use of a new unit of exchange.

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Ousmène Mandeng of London-based Ashmore Investment Management, who is a former IMF official, proposes a simpler solution: competition. The failure of "Bretton Woods II" is that too few countries are willing to play by the rules. Mr. Mandeng proposes changing the incentive to follow good economic policies by forcing governments to compete for the role of reserve currency. The G20 could encourage greater use of as many as a dozen currencies for global exchange, perhaps by instructing central banks to diversify their reserves. Mr. Mandeng reckons this would force U.S. politicians to take their deficit and debt more seriously because they could no longer rely on heavy demand for Treasuries to keep borrowing costs low.

Other ideas will emerge, including from the emerging-market governments that are so eager to change the system. The short-term winners will be currency traders, who thrive on volatility.

The price of gold jumped after Mr. Zoellick's proposal appeared in the Financial Times on Monday as some investors bet the metal is on track to return as a base for international exchange rates. Gold fell later in the week when Bank of Canada Governor Mark Carney dismissed that idea.

Millions made and lost as the result of a simple op-ed in a newspaper. And Mr. Sarkozy has barely got started. It's going to be a wild year.

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