Will a Basket of Currencies Replace the Dollar?

Robert Fisk of the Independent wrote yesterday that the Middle Eastern oil producers, plus China, Japan and France have all agreed to start trading oil using a basket of currencies – including the yen, yuan, euro, gold and a new, unified currency planned for nations in the Gulf Co-operation Council, including Saudi Arabia, Abu Dhabi, Kuwait and Qatar – instead of the dollar.

Fisk said this will start in 9 years.

But Max Keiser has heard from his contacts in Paris and the Middle East that:

  • The time schedule will be happening a lot faster than 9 years.
  • The basket of currencies against which oil is traded will include up to 50% gold
  • The G-20 Pittsburgh meeting included a discussion of using Special Drawing Rights and a basket of currencies to replace the dollar, with all currencies being adjusted and redistributed, with dollar taking a 50% devaluation to reflect debt America is carrying

I have repeatedly pointed out that the signs of moving towards a basket of currencies involving SDRs are numerous.

And Examiner.com provided a good summary of the issue in April:

The G-20 group of wealthy nations authorized the issuance of $250 billion dollars worth of an alternative currency called “Special Drawing Rights”. Special Drawing Rights (SDR), are a currency issued by the International Monetary Fund, an inernational organization which provides aid to countries which are struggling financially.

Indeed, China’s central bank recently proposed making SDRs the world’s reserve currency.

Russia also backs making the SDR the world’s reserve currency, and Russia wants the SDR to be pegged to a basket of yuans, rubles and gold (currently, the SDR is pegged to four currencies: the dollar, yen, euro and sterling).

Before you dismiss this as beyond the realm of possibility, you should note that Nobel Prize-winning American economist Joseph Stiglitz believes that the authorization of $250 billion in SDRs is an important step on the way to creating a new global reserve currency, that the shift away from the dollar as reserve curency and towards a basket of currencies actually started a couple of years ago, and that SDRs could be phased in as the world’s reserve currency within a year.

Interestingly, China has raised the possibility of an alternative peg for the SDR based upon commodities:

China’s government has floated a variant of this idea, suggesting a currency based on 30 commodities along the lines of the “Bancor” proposed by John Maynard Keynes in 1944.

(Keynes was the most prominent economist of the first half of the 20th century, conventionally credited with ending the Great Depression.)

Indeed, the head of the China’s central bank wrote recently:

Though the super-sovereign reserve currency has long since been proposed, yet no substantive progress has been achieved to date. Back in the 1940s, Keynes had already proposed to introduce an international currency unit named “Bancor”, based on the value of 30 representative commodities. Unfortunately, the proposal was not accepted. The collapse of the Bretton Woods system, which was based on the White approach, indicates that the Keynesian approach may have been more farsighted. The IMF also created the SDR in 1969, when the defects of the Bretton Woods system initially emerged, to mitigate the inherent risks sovereign reserve currencies caused. Yet, the role of the SDR has not been put into full play due to limitations on its allocation and the scope of its uses. However, it serves as the light in the tunnel for the reform of the international monetary system.

Keynes proposed that the Bancor should be fixed to a basket of 30 commodities, including gold.

Keynes’ arguments for a currency fixed on a basket of commodities was that it would stabilize the average prices of commodities, and with them the international medium of exchange and a store of value.

As China’s central banker said, the goal would be to create a reserve currency “that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies”.

But Keynes proposed a lot more than simply pegging SDR’s to a basket of currencies:

He proposed a global bank, which he called the International Clearing Union. The bank would issue its own currency – the bancor – which was exchangeable with national currencies at fixed rates of exchange. The bancor would become the unit of account between nations, which means it would be used to measure a country’s trade deficit or trade surplus.

Every country would have an overdraft facility in its bancor account at the International Clearing Union, equivalent to half the average value of its trade over a five-year period. To make the system work, the members of the union would need a powerful incentive to clear their bancor accounts by the end of the year: to end up with neither a trade deficit nor a trade surplus. But what would the incentive be?

Keynes proposed that any country racking up a large trade deficit (equating to more than half of its bancor overdraft allowance) would be charged interest on its account. It would also be obliged to reduce the value of its currency and to prevent the export of capital. But – and this was the key to his system – he insisted that the nations with a trade surplus would be subject to similar pressures. Any country with a bancor credit balance that was more than half the size of its overdraft facility would be charged interest, at a rate of 10%. It would also be obliged to increase the value of its currency and to permit the export of capital. If, by the end of the year, its credit balance exceeded the total value of its permitted overdraft, the surplus would be confiscated. The nations with a surplus would have a powerful incentive to get rid of it. In doing so, they would automatically clear other nations’ deficits.

Indeed, the IMF is now issuing its own bonds, and many countries have expressed interest in buying them. See also this and this.

Note 1: I am not saying the move away from the dollar to a basket of currencies will happen overnight. It is likely to be an ongoing, gradual process.

Note 2: Nouriel Roubini is treating this issue seriously. In a round up entitled “Ganging Up on the Dollar? Could Oil Exporters Move Away from Dollar Pricing?”, Roubini notes:

  • Intermittently, oil exporters, especially Russia, Iran and Venezuela discuss moving away from pricing oil in dollars. OPEC members have tended to be divided on this issue. A October 2009 report, in the Independent, a British paper suggested that GCC countries had discussed moving away from dollar pricing with China and Russia. although the report was denied by Saudi Arabia, the largest OPEC producer which has a very large stock of US assets, it added to concerns that key creditors might move away from the U.S. dollar.
  • A move away from dollar pricing could weaken the U.S. dollar if it reduced the use of the dollar in oil transactions and savings. Moving to a different nominal pricing structure would not in itself mean less of these transactions, but it could be a precursor…
  • Several oil exporters, especially Russia, Venezuela and Iran have significantly reduced their dollar savings but the GCC still maintains well over a majority dollar share, boosted by Saudi Arabia. Oil exporters have worried about the volatility of their earnings in real terms.
  • Deals between Chinese oil companies and Brazil, Russia and Venezuela will be partly paid back in oil not currency. Some analysts suggest that this could be be one step towards lessening the dominance of the US dollar in the oil trade, though the price will still be pegged to the predominant currency in which oil transactions take place is most important in determining the effect on the foreign exchange markets
  • al-Badri (OPEC head): OPEC might shift to non-dollar prices but it will take time, at least a decade
  • In 2008, Russia launched a ruble-denominated commodity exchange for domestic consumption, may increase use of ruble in oil-trade externally in future (NYT) but that would likely mean allowing more ruble strengthening.
  • Oil will be priced by Russian standards and paid for in rubles with the Russian trading system meant as a challenge to US economic hegemony and part of a growing global dissatisfaction with a dollar based financial system. Russia had become unhappy with what it saw as underpricing of Ural oil which is priced according to north sea blends.
  • In August 2007, OPEC worried that the real price of OPEC basket was actually lower than in 2006 despite a higher nominal price. The weak dollar lowered the purchasing power of OPEC members who source imports primarily from EU, Asia. OPEC oil price rose 130% in dollars from 2003- August 2007; 79% in euros
  • BNY [Bank of New York] noted that the Oil industry structure, trade with US lessen odds of any short-term pricing changes but reserve diversification could increase
  • Mazraati (OPEC): 73% of OPEC nominal oil revenues from 1970-2004 were lost to imported inflation and dollar depreciation
  • Richard Berner [Morgan Stanley Global Economic Forum]: OPEC production cuts offset weak dollar; diversification (incl Iran’s demand for non-$ payment) adds to dollar weakness
  • Brad Setser notes that currency of oil exporters savings and the settlement not pricing currency matters (2007)

Note 3: For a counter-argument by Mish, see this and this.

This entry was posted in General. Bookmark the permalink.