Will a Basket of Currencies Replace the Dollar?

→ Washington’s Blog.

As everyone knows, 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 (as Tyler Durden also noted) 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.

Comments

[Anonymous]

If China stiffed our banksters on billions in forex trades last November and WE picked up the tab for this as part of
the "too big to fail" bailouts, where is the goddamn
public disclosure from Treasury or the Fed?
Anyone?

[Harbourcity]

I find the lack of acceptance of the concept of basket of currencies or commodities as a viable reserve "currency" odd.  If you doubt it due to the premise that the US won't allow it, I'd understand that jadedness.  If you doubt it because it hasn't been done before... what are you doing here?

[jdun]

It's called politics. The devil is in the detail.

If you’re going to replace the dollar, do it right. Replace it with another single currency or commodity like Gold.

[Carina]

The trend is your friend, except at turning points.....

[miramarbeach]

Please everyone, short the dollar. Enough of this 97% USD bear stuff, get it down to 99% bears, or better yet, I'll volunteer to be the one and only Bull. This reminds me of how we were running out of oil at $150 but now at $70 we have plenty. As soon as the dollar jumps, this conversation will be forgotten.

[crzyhun]

Great beach, mirmar, spent two summers there 1960 /61. Got tan as a chocolate drop.

Oh and beware dollar bears I agree; but, beware dollar bull too. So, I guess jack be nimble, jack be quick somehow.

The threat to the dollar isn’t from decisions taken at secret meetings in Riyadh, but from those debated at public meetings in Washington. Who needs an exotic conspiracy when you’ve got home-grown stupidity?

— Kevin Williamson

[RagnarDanneskjold]

The U.S. trade deficit and global imbalances are a direct result of the dollar being the reserve currency. The U.S. must flood  the world with dollars to satisfy the demand for liquidity. I don't see how the U.S. can possibly put its house in order under the current regime without completely wrecking the global economy unless it is accompanied by relief from reserve status, or unless the U.S. forces the rest of the globe to increase its use of the dollar. 

A Machiavellian strategy would be to take the world on its bet and position the U.S. for rebirth. Get them to dump their dollars now, use the weak currency to inflate debt away, position away from oil to the extent it is possible, and massively cut taxes and regulation to absorb the dollars from the supply side. Once the U.S. is coming out the other side, the weakness of state run capitalism across the globe will be self-evident. Let the greenback strengthen and then use it to crush America's enemies permanently. Seemed to work in the 1980s.

[jdun]

Good luck at making "basket of currencies" work in real life.

[Anonymous]

Assuming that the Renminbi is included in the currency basket, will China a required to let the currency float ?

Seems to me that any currency part of the basket would need to be managed in more or less the same ways.

[DaddyWarbucks]

Will the basket have a hole in it or some other gimmick for regularly fleecing the little people?

I'm sure the basket will be in the custody of GS, the world bank, the IMF, or some other trustworthy party.

[Hephasteus]

Can we call it a magician box instead of a basket. Or a handbasket to hell or something more relevant?

[AR]

Be careful what they wish for.  We will look forward to trading a volatility product specially created to mirror and track" this so-called "SDR or International Bancor" administered by the IMF (and yes, they'll create one).  History will show that the IMF is hardly a pillar of neutrality, stength, and stability.  Therefore, let the egos loose in that nuthouse.  That ought to be a fun product to trade.  Did someone just say they it will "marked" to 30 different commodities?  Yes, that was Mr. Xie over there in the corner from China and that other guy from Russia, Putin.  Hmmm, that's what we thought...

[Harbourcity]

Yes, the IMF isn't neutral seeing as the US is a major contributor.  That said, if the basket of currencies can properly reflect the world financial markets (including China, Russia etc) then it's a big step towards some sort of level playing field.

[Daedal]

Goldmember

[Carina]

This is pure, unfounded speculation.  There are more dollar-denominated assets than any other.  As asset prices deflate, the supply of dollars shrinks and the price of the dollar rises.  We haven't even seen the beginning of this.  The dollar supply is contracting, not expanding.  The "news" that we hear today about the dollar's imminent demise is pure posturing.  Be short the dollar at your own peril.

[Anonymous]

You can't be serious??

[Harbourcity]

The only reason that the shit hasn't hit the fan is because the banks are sitting on this expansion of the US dollar supply.  If the banks flood the market with USD (once interest rates increase) chaos will ensue.  Every country knows this and is either trying to get out of the way (out of Treasuries) or change the situation in time (change the reserve currency) to minimize the effect of the US economy collapse on their country.  If most economy's use the USD to transact, a collapse brings on chaos.

Let's hope that a new reserve currency appears before the US economy collapses or we're all directly or indirectly in for a shit storm.

[Daedal]

"The dollar supply is contracting, not expanding. "

LoL!