China's united currency idea divides nations

China wants to create a new currency for international finance reserves to help deal with the global credit crunch.

Now, some economics watchers see that notion as self-serving, others as timely. But whatever the majority opinion of China's grand idea, the single currency theory certainly isn't new.

In fact, China's idea — to make a new standard for international financial reserves — revives a debate that can be traced back at least a half a century.

Back in the 1950s, if someone in China wanted to buy an American bond, that person would ship a sliver of gold — or a piece of paper representing the shiny yellow metal — to the United States to pay for the financial instrument.

Fast forward two decades and the American dollar had cemented its superiority as the currency of choice among international traders. After all, people were only interested in holding the cash of a country that was stable, which, in the middle of the last century was really a club of one — the United States. 

Now, the U.S. greenback, much like the American economy, has fallen into disfavour with foreign investors and governments.

Still, with the United States remaining the biggest economy on the planet, many traders probably would hesitate before agreeing to dump their dollars as the international payment standard.

"The benefits (of a new currency) are far from certain and this is certainly not a "shovel-ready" project," said TD Bank senior economist Richard Kelly in a recent commentary on the subject.

Debating a single coin

To be clear, China is not proposing a single currency that individuals and companies in most countries would use for domestic transactions à la the European Union's euro.

Instead, Zhou Xiaochuan, the governor of China's central bank who floated the idea in March, was suggesting an international standard for foreign currency reserves. That is the cash of other countries that central banks keep on hand to trade with and invest in other nations.

As well, governments hold such reserves as a way of controlling the value of their own currency.

As of the end of March 2008, Canada held slightly more than $43 billion U.S. in foreign reserves, more than $39 billion in the form of various securities and debt instruments and the remainder in deposits.

These reserves, for instance, allow Ottawa to manage the value of an undervalued Canadian dollar by using the foreign cash to buy the Canuck buck on the global currency market.

Right now, many countries hold a large portion of their reserves in U.S. dollars. The thinking is that the American greenback will keep its value against the cash of most other countries, be it zlotys, reais or Congolese francs.

U.S. economic slump

But that was before the global credit crunch. 

Now, $2.5 trillion in American taxpayer cash later, and fears of an impending crash in the U.S. currency — not its stable value — is top of mind among foreign exchange types.

"If there is any doubt as to how the forex markets feel about the Fed’s plan to purchase over $1 trillion in U.S. government bonds, consider that the dollar just recorded its worst weekly performance in 24 years, while the euro simultaneously recorded its strongest week since its inception in 1999," wrote Adam Kritzer recently on his well-followed foreign exchange blog.

And China is eyeing its own holdings of $1 trillion in dollar-dominated assets, as well as its much-maligned domestic currency, and thinks a new world cash standard might be the answer.

Thinking outside the box

So, Zhou wants to expand the importance of an obscure financial bit of accounting known as special drawing rights, or SDRs.

SDRs have been around since the time of the post-Second World War Breton Woods agreements, which established institutions such as the International Monetary Fund and World Bank and basically defined the global system of international finance.

But these SDRs were not really very important, used basically as a way for countries to figure out their contributions to and withdrawals from some international institutions.

The value of these drawing rights now is based upon a basket of four currencies — the Japanese yen, the euro, the British pound and the dollar.

The Chinese government proposal would expand the number of currencies involved in valuing the SDR and establish a settlement system for international transactions based upon the new currency.

American 'no'

U.S. Treasury Secretary Timothy Geithner, among others, has pooh-poohed the Chinese idea, arguing it would be a bad time to inject more uncertainty into the world economy.

Washington might have more practical reasons for wanting to maintain the status quo, experts said.

For one thing, President Barack Obama is trying to re-establish the U.S. economy's pre-eminent position among economic powers. That effort likely would be damaged if the American buck were downgraded by the financial community.

In addition, the use of the U.S. dollar as an international means of exchange also provides some extra demand for the greenback. Such popularity provides a floor shoring up the value of the dollar, which, in turn, removes additional pressure to raise interest rates.

China wariness 

Of course, the Chinese government has its own agenda, namely that American trillion-dollar stimulus plan.

Many analysts believe that all that new cash will hike the U.S. inflation rate once the American economy makes a recovery. If that prediction is accurate, the Chinese U.S. dollar holdings would lose their value, likely forcing Beijing to dump its American bonds and other securities.

Worse still, any hit to the international value of the U.S. currency would boost the worth of China's yuan. But a stronger Asian currency also would result in fewer Chinese exports, a situation which could damage that country's trade-dominated economy.