New rules are being written for the International Monetary Fund (IMF). For some time now China and Russia have expressed a desire for a new reserve currency for the world other than the dollar. The dollar has effectively been the world's reserve currency since World War II. This has allowed the US to go tremendously into debt while borrowing huge amounts of money from China, Saudi Arabia and other nations. Because of the global economic crisis which many nations blame on the US, China has complained recently about this reality. They own approximately one trillion dollars of US Treasury bonds and are worried that they won't get their money back.
In an article in the Washington Post today the IMF has essentially set up a world reserve currency:
Yesterday, the IMFC backed plans to dramatically increase the fund's financial war chest to cope with the crisis. At the London summit, world leaders including President Obama called for the IMF, which has the capacity for about $250 billion in lending, to beef up its resources to $1 trillion.
That money would be raised in two ways. First, through $500 billion in pledges from major governments. But the IMF also has the ability to effectively print its own money, and has plans to issue about $250 billion in its currency, which has a value based on the dollar, the euro, the yen and the pound.
The IMFC said the fund had effectively secured about half the $500 billion from governments, though some critics were less certain of that. Japan, the United States and the European Union, for instance, have all committed to give $100 billion. But to date, only Japan's commitment has actually come in. Obama sent Congress a letter last week urging support for the U.S. pledge.
The fund, the IMFC said, may also "consider market borrowing" to increase its resources. That appeared to refer to plans at the IMF to issue bonds similar to, say, U.S. Treasury bills. That would provide new ways for developing giants such as China to invest in the fund; the IMF and China are close to agreeing on a deal in excess of $40 billion.
So the IMF has the ability to print its own money! This is just what China and Russia have asked for. The dollar will no longer be able to dominate the world's currency markets. The US will no longer be able to borrow billions each day and run up its astronomical national debt even further. Furthermore, the IMF will issue bonds which the Chinese can then invest in instead of US Treasury bonds. They will constitute then a "savings account" or a repository of value for excess Chinese profits.
Consider this article from the Wall Street Journal:
BEIJING -- China called for the creation of a new currency to eventually replace the dollar as the world's standard, proposing a sweeping overhaul of global finance that reflects developing nations' growing unhappiness with the U.S. role in the world economy.
The unusual proposal, made by central bank governor Zhou Xiaochuan in an essay released Monday in Beijing, is part of China's increasingly assertive approach to shaping the global response to the financial crisis.
Mr. Zhou's proposal comes amid preparations for a summit of the world's industrial and developing nations, the Group of 20, in London next week. At past such meetings, developed nations have criticized China's economic and currency policies.
This time, China is on the offensive, backed by other emerging economies such as Russia in making clear they want a global economic order less dominated by the U.S. and other wealthy nations.
However, the technical and political hurdles to implementing China's recommendation are enormous, so even if backed by other nations, the proposal is unlikely to change the dollar's role in the short term. Central banks around the world hold more U.S. dollars and dollar securities than they do assets denominated in any other individual foreign currency. Such reserves can be used to stabilize the value of the central banks' domestic currencies.
Monday's proposal follows a similar one Russia made this month during preparations for the G20 meeting. Like China, Russia recommended that the International Monetary Fund might issue the currency, and emphasized the need to update "the obsolescent unipolar world economic order."
Chinese officials are frustrated at their financial dependence on the U.S., with Premier Wen Jiabao this month publicly expressing "worries" over China's significant holdings of U.S. government bonds. The size of those holdings means the value of the national rainy-day fund is mainly driven by factors China has little control over, such as fluctuations in the value of the dollar and changes in U.S. economic policies.
The proposal is unlikely to change the dollar's role in the short term? The WSJ article was written on March 24, 2009, and the Washington Post article, on April 26, 2009. How's little over a month for "a short time"?
The implications for the debt based economy of the US are ominous. With a budget deficit of one trillion dollars, the US must borrow $2.74 billion per day just to keep its economy afloat. The Chinese are not likely to be putting all their excess profits into dollars in the future so what's the US going to do? If it can't borrow money, it will have only one option: to print it. And then the likely result of that is hyperinflation. In short the whole US capitalistic system is likely to come tumbling down. At that point the US will have to invent a whole new economic system not based on the dollar. Probably a new currency will be put into effect with the dollar ending up in the dustbin of history. This is not a pleasant prospect for most Americans who will have their standard of living drastically lowered. The old way of running trade deficits with China and Saudi Arabia among others with dollars piling up in those countries which are then used to buy US debt will be over. US dominance over the world economy will end.
The philosophy of the IMF is also changing. For the last 30 years or more, the IMF has been dominated by the US and its policy of unfettered capitalism. Countries needing help from the IMF have had to agree to draconian policies including privatization of public institutions, "free" trade, lowered taxes and deregulation. When imposed on poorer countries in return for a bail-out, these policies effectively cut the safety net out from under the poor and resulted in widespread suffering. Milton Friedman, Alan Greenspan and the Chicago School of Economics caused IMF policies to undermine the welfare of the poor. Now that's changing as the US loses credibility on the world stage and other countries such as China gain. No longer will austere measures be imposed on countries in need of a bail-out from the World Bank. This will make it easier for socialist countries to maintain their safety nets and not pull the rug out from under the poor.
While China gains ascendency on the world stage, the US is saddled with a military empire including 737 military bases manned with 2.5 million personnel in about 130 countries around the world. The US military budget takes up over half of US government expenditures and is currently over one trillion dollars annually if interest on the national debt and veteran expenditures are taken into account. So if the US could not borrow $1 trillion annually, it would have to drastically cut its military budget which is probably not such a bad thing. The demise of the US world empire would relieve the US of being the world's policeman. Other countries would have to take up the slack and there would probably be far less meddling in other countrys' affairs. Currently, such countries as France and Germany are getting by with letting the US take care of their share of protection at US expense, of course. If they want protection in the future, they will have to shoulder their share of the financial burden.
The US will not be able to have a debt based economy fueled by consumer consumption and cheap imports. This is probably a good thing as well as the US will have to redevelop its own manufacturing base and rely on its own products rather than importing so much from abroad. The change in the current world order will allow the US to start building its house on a rock again instead of the sand castle its been building for the last 50 years.