Shifting wealth: Is the US dollar Empire falling?Helmut Reisen20 June 2009, VOXIf history is any guide, the Chinese renminbi will soon be due to overtake the US dollar, just as the dollar replaced the pound sterling last century. But will the renminbi be ready for reserve currency status? This column discusses the issues at hand and explains why some experts would prefer the IMFs Special Drawing Rights as the next global reserve currency.Just ahead of the G20 London Summit in April, Zhou Xiaochuan (Chinas central bank governor) proposed replacing the US dollar as the international reserve currency with a new global system controlled by the IMF. The main global reserve currency would be represented by a basket of significant currencies and commodities, an extended version of the Funds Special Drawing Rights (SDRs). Chinas call for an overhaul of the global currency reserve system has been echoed by Russias President Medvedev as an important building block of a new global financial architecture.Major emerging economies, often net creditors to the rest of the world an with substantial holdings of US government debt, fear the potential inflationary risk of the US Federal Reserve printing money to finance bank bail outs. Their fears may be based on the “Triffin Dilemma” that postulates the necessity of US external deficits as long as the US dollar is the only global reserve currency. In a famous warning to Congress in 1960, the Belgian Yale economist Robert Triffin explained that as the marginal supplier of the worlds reserve currency, the US had no choice but to run persistent current account deficits. As the global economy expanded, demand for reserve assets increased. These could only be supplied to foreigners by America running a current account deficit and issuing dollar-denominated obligations to fund it. If the US stopped running balance of payments deficits and supplying reserves, the resulting shortage of liquidity would pull the global economy into a contractionary spiral (Triffin, 1961). Note that demand for foreign exchange reserves forces developing countries to transfer resources to the countries issuing those reserve currencies a case of “reverse aid”.China holds a huge official portfolio of US government bonds. It has already suffered valuation losses on its sovereign wealth funds that invested heavily in US financial intermediaries. But could China suffer valuation losses as a result of inflation and dollar devaluation, as is often maintained? Dollar weakness against other key currencies will not by itself inflict valuation losses on Chinas central bank as there would be no change in the renminbi value on the dollar component of Chinas huge FX reserves. It is renminbi appreciation against those currencies held in the FX reserves often claimed by the West that would inflict valuation losses as measured in renminbi.In the recent decade, the US has used (and perhaps abused) the privileges that its reserve currency status has conveyed to the host country. To see this, look at Table 1, which displays a matrix of the global functions of money often attributed to Peter Kenen (Group of Thirty, 1983).By enlarging the scope of issuers and investors, the reserve currency lowers borrowing costs and facilitates balance of payments financing; Americans have outspent their national income by an accumulated 47.3% of GDP since 2000, depressing US treasury rates until 2005 up to 130 basis points as the world (mostly Asia) reinvested the corresponding surpluses mostly in US treasury bills (Warnock & Warnock, 2006). The additional demand for money creates seigniorage revenues; last year the US Fed made a net interest income of $43 billion, as the US dollar in circulation is, in effect, an interest-free loan by the public to the central bank (Economist 2009). And, though its benefits are harder to quantify, currency use in key markets for commodities or trade invoicing shifts exchange rate risk to third countries, insulating the reserve currency host country.Table 1. Matrix of international currency usePrivate useOfficial useMedium of exchangeVehicle currencyIntervention currencyUnit of accountQuotation currencyAnchor currencyStore of valueInvestment, debtFX reserve currencyIn turn, the US dollar is providing (microeconomic) network benefits; it has the attributes of a natural monopoly like the English language these days. (By contrast, the IMFs Special Drawing Rights SDRs are no more than the equivalent of Esperanto). Sixty-four percent of the worlds official foreign exchange reserves are currently held in US dollars; roughly 88% of daily foreign exchange trades involve US dollars (Humpage, 2009). Global trade is facilitated by the use of just one currency, liquid debt markets allow Central Banks to intervene in foreign exchange markets as to smooth currency fluctuations, savers can escape inflationary governments by deposit d