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United Nations Turn Dollar Bears
Debates about the U.S. dollar losing its status as the main reserve currency are back, and are coming from an international organization, the United Nations.
These issues were raised during this year’s U.N.’s Conference on Trade and Development that had members saying that the dollar’s hegemony is likely to expose confidence problems for the emerging economies, since currency risks have the biggest impact to international macroeconomic flows.
The vast majorities of emerging economies are dependent on inflows to sustain their government’s investments, or are reliant on international investors for direct investments to create jobs and to stimulate the economy by shifting the aggregate demand outwards.
However, foreign investments are substantially reduced by currency risks, that are the biggest uncertainty that overseas investors face when investing in an emerging economy. Currency uncertainty can be caused mainly by two problems: internal issues (mainly political) and by huge swings in the value of the global reserve currency; the U.S. dollar.
Above average swings in the value of the global reserve currency were highlighted very well during the 2008-2009 credit crisis un-winding, when the emerging currencies suffered huge losses due to the dollar’s strength, that brought overseas inflows to a sudden halt, which gradually became huge outflows, as existing investment was repatriated.
Some of this huge volatility could have been avoided if the global reserve currency was a supranational currency instead of the dollar, the U.N. members say. Moreover, just ahead of the credit crisis, the opposite side of an imbalanced reserve currency was seen when the dollar’s weakness (this time) was ready to send the global economy into a strong slow-down due to the huge increase in the price paid for oil and other commodities.
The UN’s answer to these problems are seen in the special drawing rights, or the SDRs, which is the International Monetary Fund’s currency, that until recently had been used only for accounting purposes.
The idea of replacing the dollar’s reserve status with SDR is supported, and had been advanced by the BRIC countries, (Brazil, Russia, India, and China); the same four countries that are forecast to form the largest economies in the world by 2050.
The value of the SDR is determined by a basket of currencies, made up by the U.S. dollar, with a 44% weight, the Euro, which has a 34% weight, the British pound, with an 11% weight and by the Japanese yen, which represents 11% of the basket.
It is important to note that the weight of each currency changes from time to time based on the international economic flows. The last time that the weight in the currency basket changed was in 2006, while the next one is forecast to happen by 2010.
As any other currency, the SDR has its “own” interest rate and is calculated on the aggregate money market rates in the U.S., Euro-area, U.K. and Japan. Mainly, the SDR interest rate is calculated based on the three-month Eurepo rate, three-month Japanese Treasury Discount bills, three-month UK Treasury bills and three-month US Treasury bills.
It is important to note that these are market yields and are out of the reach of any central banks (to some extend). In other words, central banks can influence these yields, but cannot directly control them.
It is argued that having SDR as the global currency reserve would off-set moves in global commodity markets that are tied to Usd strength or weakness. The balancing of petro-dollars to global reserves would minimize the threats to inflows, and the timing of outflows, that are essential for emerging markets to evolve.