International Reserve Currency: What’s Next?

This post is part of Cram Session, an ongoing weekly series from the Whitehead Journal of International Relations and Diplomacy. Each week a member of the Whitehead Journal will discuss the history and future of a wide variety of topics pertaining to International Relations


After WW2, with the exception of America, the global economy was in shambles. America experienced an influx of workers and underutilized factories, while almost all other countries were left with a destroyed infrastructure and a devalued forex currency trading.  In July 1944, 730 delegates met in Bretton Woods, New Hampshire to determine how the global economy would rehabilitate itself.  According to Ngaire Woods, “The challenge was to gain agreement among states about how to finance postwar reconstruction, stabilize exchange rates, foster trade, and prevent balance of payments crises from unraveling the system.”  The resulting agreements were discussed in 1944 by The Economist:

The Conference split itself up into three Commissions: the first to deal with the monetary proposals for setting up an International Monetary Fund; the second to discuss the proposals for setting up a United Nations bank for reconstruction and development; the third, a “remnants department,” to cover any subject outside the scope of the first two commissions…”

From an international currency standpoint, the Conference had two large implications.  First, due to the relative stability and potential of the American economy almost all Western nations’ currencies were pegged to the USD.  In turn, the USD was pegged to gold.  In essence, the value of most currencies was determined by the level of gold held by the United States- giving America vast control over the international financial system.  This agreement largely met the needs of the world for over 20 years until a large current account deficit, costly foreign wars, and the American government’s refusal to reduce spending led the Nixon administration to abandon gold convertibility and effectively end the agreement.

By abandoning a fixed exchange rate the United States gained numerous domestic advantages.  According to Paul Krugman:

There are powerful advantages to such an unconstrained system. Above all, the Fed is free to respond to actual or threatened recessions by pumping in money. To take only one example, that flexibility is the reason the stock market crash of 1987–which started out every bit as frightening as that of 1929–did not cause a slump in the real economy.

However, these advantages do not come with out disadvantages.  According to David Stockman, since President Nixon abandoned the Bretton Woods agreement, “we (America) have lived beyond our means as a nation for nearly 40 years.”

Since the abandonment of the Bretton Woods System, an informal international reserve system has developed in its place. “This system involved the accumulation of large (USD) dollar reserves by emerging markets” The Economist proclaimed, “and it has been sorely tested by the rise of large global imbalances and destabilizing capital flows.” The reliance of the USD as a reserve currency has benefited America in a variety of ways. Writing at Michael Pento argues that, “The “king dollar” status allows the U.S. to consume much more than it produces without having its currency collapse. It also keeps interest rates unnaturally low, which provides a tremendous boost to economic growth.” However, this relationship is “unlikely to persist for much longer.”

What comes next?

There is not a general consensus of what the future of international monetary transactions holds. At a conference in Paris, Chile’s Finance Minister Felipe Larrain remarked, “We are in a state of flux in the international monetary system. The problem is that we don’t really have a perfect substitute (for the USD).”  China suggests replacing the dollar with an international currency disconnected from individual countries ( The Wall Street Journal speculates that China is taking steps to “foster global trading in its currency.”  These steps involve allowing individuals to convert up to $4,000 to yuan a day and increasing the amount of exporters who can use yuan for international transactions from “a few hundred to nearly 70,000”.

Barron’s reports that Japan supports the idea of using the Euro as a reserve currency while the I.M.F.’s leader Dominique Strauss-Kahn has pondered the idea of creating a new global reserve currency unrelated to the Euro or the USD. According to the New York Times, French President Sarkozy “has argued that the dollar’s role as the single global reserve currency does not reflect an increasingly multipolar world.”  Further, the head of the World Bank, Bob Zoellick, suggested adopted a peg to a basket of currencies including gold (Financial Times- Requires Registration). Zoellick’s gold standard suggestion is in contrast to the views of Economist John Maynard Keynes who commented “in truth, the gold standard is already a barbarous relic.

More analysis:

While instituting a gold standard may be a barbarous idea, it may be worth examining the role of the USD in international transactions (Open Economics).

Randall Forsyth of Barron’s speculates that 2011 could mark the end of the global domination of the dollar.

Matt Yglesias speculates on the idea of “small currency unions” including unions within regions of the United States. (via The Economist)

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