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Could SDR’s be the next reserve currency?

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The world’s economy and political landscape have experienced some serious earthquakes in the last 18 months, making the topic of a new currency standard a contentious one. The pundits are polarised, some are for a complete revaluation, they feel using the Dollar as the reserve currency is no longer viable, while others predict chaos if the status quo changes, says FXTM’s Staff Writer, Nikola Grozdanovic

If we look at recent history, it reveals that the entire world’s economy would have to be crisis for the majority of nations to come together and agree on currency evaluation. In the 1940s, the Bretton Woods system was established and effectively fixed the gold standard to the US dollar, creating a ‘pegged rate.’ It was a global response to two World Wars and a possible second Great Depression. The Allied nations bandied together, pointing at poorly managed post-WWI economy as a major precursor of WWII, and agreed on a system that relied on a controlled market economy to ensure that currencies stayed within a 1% parity with the dollar.

The USD became the primary reserve currency, as the standard measure of the world’s economic temperature. In many ways, the Bretton Woods system was an experiment on a massive scale, and it failed just as many suggested it would. When Nixon issued the order that stopped the convertibility of the dollar to gold directly in 1971, it was the final nail in the Bretton Woods coffin. Market forces began to dictate the floatation of a number of currencies and, by 1973, the current system of fluctuating exchange rates that dominate forex trading was born.

A popular topic in the currency revaluation discussion is the nature of fixed versus floating exchange rates. For central banks to seriously re-evaluate the global currency system, they would need to surrender at least some control of national fiscal policy. Even the economic crisis in 2008 was not sufficient motivation to encourage a change; not one nation was desperate enough to make major changes to national economic policies. Nevertheless, the crisis shook the financial world enough to make us look at how we can manage currency volatility in a more controlled way.

Special Drawing Rights (SDRs) is China’s choice for an alternative reserve currency. When it was created as a direct reaction to the Great Inflation in the late 1960s, the SDR was valued at 0.888671 grams of gold, or the equivalent of one dollar. Once Bretton Woods collapsed, the SDR was re-evaluated as a basket of currencies – that is, it’s made up of a number of major currencies including the USD, EUR, GBP, JPY and (as a late addition) RMB.

However, the SDR has a serious liquidity issue. At the moment, there are not enough ‘baskets’ to support global monetary policies. We’re still in the dark on whether this is a positive or a negative for China specifically, but that’s not stopped some experts from anointing the RMB as the world’s next reserve currency. The Chinese economy, notably its GDP, is predicted to outshine its Western counterparts within the next 20 years and China’s RMB, being part of the SDR, has given China more credibility on the global economic stage.

As long as the current system remains free floating and volatile, currency revaluation on a global scale will remain a trending topic. Geopolitical conflicts and central bank policies will continue to influence price movement. If the past is any predictor of the future, economists in the pro currency revaluation camp will feel empowered, but the fact remains that a monumental world event is required for such a massive economic change to be justified and adopted. Is global monetary policy revision a sure thing? Most economists will not hang their hats on it but, considering the political swings and shocks we’ve encountered recently, it is entirely possible.

 

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NOTES TO EDITORS

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