On March 23, the governor of the central bank of Communist China called for the end of the U.S. dollar as the world’s reserve currency and for its replacement with an artificial global paper currency to be managed by the International Monetary Fund. However, there has been for centuries a global money and one not easily open to discretionary manipulation by governments: gold.

China has invested about $2 trillion in U.S. government and private-sector financial securities. The Chinese monetary authority is concerned that the Federal Reserve has been expanding the American money supply at such a dramatic rate over the last six months that future price inflation will result in a falling dollar on the foreign exchange markets. This would seriously dilute the real value of China’s dollar holdings in the United States.

Treasury Secretary Timothy Greithner caused a brief tumble in the dollar's value when he hinted that the U.S. might be open to a diminished role for the dollar as an international reserve currency. But he quickly corrected his statement and said that Washington considered the dollar a good investment and a sound currency for global transactions.

The Chinese have proposed to dig out of the IMF closet an artificial and imaginary currency called Special Drawing Rights (SDRs) that was originally created back in 1969. It was meant to be a tool to enable governments around the world to have extra reserves to expand their domestic money supplies to fund government budget deficits and to help manipulate a country’s currency on the foreign exchange market. It was nicknamed “paper gold” because it was supposed to be a magical money-creating machine to feed the spending of governments everywhere.

A total amount of 21.4 billion SDRs were allotted to governments in the 1970s and early 1980s. But the SDR has primarily been used as an ethereal unit of account on the IMF’s accounting books. Nominally one SDR is equal to a dollar, but its exchange value on the global market as an imaginary money is based on a price index derived from the exchange rates of a small basket of currencies: the dollar, the euro, the pound, and the yen.

After nearly 30 years, the supply of SDRs is about to increase by $250 billion based on the agreements reached by the G-20 in London on April 3 for an 10-fold increase. Recipient countries will be able to use their portions to SDRs as currency reserves to finance their national budget deficits, or to trade way on the foreign exchange market to buy one of the major "real" currencies to pay off their foreign debts or fund imports. 

The chart, below, tracks the imaginary exchange rate of how many dollars per SDR from 2000 to 2009.

Source: International Monetary Fund

In February 2002, it would have taken $1.23 to buy one SDR (if the SDR was a real currency traded on the market). In July 2008, it would have taken $1.63 to buy an SDR, or a one-third decline in the dollar’s value relative to this imaginary SDR over five years. In March 2009, the dollar was still down about 20 percent compared to 2002. Another way of saying this, of course, is that the dollar has significantly fallen over the last five years relative to a composite index of the euro, pound, yen, and the dollar itself.

What the Chinese want, and they have been backed by the Russian government and a United Nations advisory committee headed by American economist and Nobel Laureate, Joseph Stiglitz, is two changes. First, they want an enlargement of the SDR index to include many more currencies, including the Chinese yuan and the Russian ruble, to diminish the impact on the average value of the index because of  fluctuations in the exchange rate of any one currency. They also want the SDR under IMF control to eventually become a real currency that would serve as a new international reserve currency with its value maintained within a given range as measured by the enlarged basket of currencies included in the index.

What seems to be missed in the case for an actual SDR currency is precisely that it would be a “paper gold,” not real gold. Under the old gold standard, particularly before World War I, the quantity of gold money in the world was dependent upon market forces. Gold prospecting, mining, and minting into coin or bullion were determined by the demand for gold (for both monetary and non-monetary uses) relative to the costs of bringing it to market. The amount of gold money was under the sway of the competitive interaction of supply and demand, and was relatively free of political manipulation and abuse.

The danger from all forms of paper money controlled and regulated by governments or their appointed central banks is that they remain creatures of the political process, and dependent upon the knowledge and policy preferences of those who have the power over the monetary printing press.

The history of paper monies is a sorry story of inflations, currency depreciations, and resulting social and economic disorder. (See, “The Lasting Legacies of World War I: Big Government, Paper Money and Inflation,” AIER Economic Education Bulletin, Vol. XLVIII, No. 11, November 2008.)

Introducing a new international paper currency managed by the IMF would create a myriad of global and political problems. First, it might be necessary to legally mandate the use and acceptance of SDRs by, eventually, all governments and private traders around the world. Some form of international legal tender law would have to be imposed.

Second, there would have to be some acceptable rule concerning the creation and allocating of SDRs among the nations of the world. Would it be on the basis of a nation’s contribution to global GDP, or according to a nation’s percentage of the world population, or some measure of a nation’s average standard of living or level of poverty, or  . . .?

Any selected benchmark has huge potential for generating international disagreement and dispute, since any one method for apportioning SDRs would inevitably be viewed by some nations around the world as shortchanging them relative to other countries receiving larger allotments of SDRs.

Third, the IMF would need to have a special global central bank division that would track fluctuations in the SDR index and determine whether the quantity of SDRs should be increased or decreased and by how much. In addition, if global or regional economic crises were to arise, the IMF central banking authority would have to decide on the appropriate SDR monetary policy. This global monetary authority no doubt would come under the pressure of member governments all having their own notions of the politically and ideologically desirable monetary policy to follow.

Institutionally and politically, any such transition to a new global currency would be a slow and difficult process, given the continuing predominant position of the U.S. economy in international trade and finance. Earlier proposals to oust the dollar from its reserve currency status -- such as the Japanese desire a couple of decades ago to be paid in yen rather than dollars in its international transactions -- came to naught.

But why open this global can of worms when individual governments could get their own monetary and fiscal houses in order by anchoring their individual national currencies in terms of a commodity like gold, once again?

As in the 19th century and early 20th centuries, the gold standard would serve as an international money standard, with national currencies set at fixed rates of redemption and exchange in terms of a quantity of gold. The gold standard would not carry with it the heavy and inescapable baggage of political manipulation and interest group politics that plague government managed paper money systems.

But then, again, maybe that is why the IMF's "paper gold" would be preferred to a real gold standard. It will enable governments to create more money out of thin air to spend on special interest groups and desired ideological projects.

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