China proposes replacing US dollar with new international currency

Sources: China calls for new reserve currency to replace dollar, Financial Times; China Urges New International Reserve Currency Over Time; Dow Jones Deutschland

China’s central bank proposed the creation of a new international finance system today. The system would be controlled by the International Monetary Fund (IMF) and its primary goal would be to create a reserve currency that is not dependent on the financial health of individual nations. This new currency is intended to replace the US dollar as the international reserve currency. The proposal was presented in an essay written by Zhou Ziaochuan, governor of the People’s Bank of China, and posted on the bank’s website.  Analysts suspect the proposal is an indication that the Chinese government fears that actions taken to stabilize the domestic US economy could have a negative impact on China.

Zhou’s essay did not specifically mention the US dollar, but it is considered a critique of the current monetary system, which is centered primarily around US currency. The essay suggested that depending on a national currency to act as an international currency is no longer desirable and that the international community should work towards creating an international reserve currency that is able to remain stable over time. Continued stability would be more likely in the new system than in the current one because problems in individual nations, such as the financial crisis rocking the US and the rest of the western world, would be less likely to unbalance the entire international financial system if the system is not centered around one national currency.

In place of the current system, Zhou suggested expanding the role of Special Drawing Rights (SDRs). SDRs were first introduced as part of the Bretton Woods international financial system, which collapsed in the 1970s. Today, SDRs are based on four currencies, the US dollar, the Yen, the Euro and the Pound Sterling, and they are used as units of account by the IMF.  China proposes adding more currencies to the SDR system to include all major economies and setting up a settlement system between SDRs and other currencies so that they could all be used in international trade and financial transactions. The proposal would also require that member countries entrust portions of their SDR reserves to the IMF to manage collectively on their behalf so that the SDRs would eventually replace existing reserve currencies. This system is not expected by anyone, including China, to be implemented immediately. Rather, China urges that the international community work to develop this system in the future and expects that its development will take a great deal of time.  A similar system was proposed by John Maynard Keyes in the 1940s.

Questions

(1) Is the creation of a new international currency a good idea? What are the pros and cons of instituting such a system?

(2) What impact would the demotion of the US dollar from being the primary international currency have on the US financial system? How would it affect the US economically? Politically?