Intraregional Cross‐holding of Reserve Currencies: A Proposal for Asia to Deal with the Global Reserve Risks

• Date: 01 July 2013
• Author: Bijun Wang,Gang Fan,Yiping Huang
• DOI: http://doi.org/10.1111/j.1749-124X.2013.12026.x
• Published date: 01 July 2013

14 China & World Economy / 14–35, Vol. 21, No. 4, 2013

©2013 The Authors

China & World Economy ©2013 Institute of World Economics and Politics, Chinese Academy of Social Sciences

Intraregional Cross-holding of Reserve Currencies:

A Proposal for Asia to Deal with

the Global Reserve Risks

Gang Fan, Bijun Wang, Yiping Huang*

Abstract

Economists have put forward various proposals to deal with the growing risks of the global

reserve currency system. In this paper we recommend that Asian economies hold each

other’s currencies as part of their foreign reserves. Different from crisis-fighting currency

swap arrangements or crisis-rescuing fund mechanisms, this mechanism means that reserves

would be held, with a regular arrangement in place and on an ongoing basis. We propose

that the global reserve system should be pushed in the direction of diversification, which

could be a transitional step toward a new single reserve system. This mechanism would not

necessitate any currency being a globally accepted reserve currency but would mean that

every currency carried some weight in the reserve system. Establishment of such a system

would require significant development of regional bond markets and facilitation of

macroeconomic surveillance among the economies.

Key words: Asia, cross-holding of regional currencies, global reserve system, US dollar

JEL codes: F330, F360, F420

I. Introduction

The global financial crisis has revealed some fundamental defects of the current international

monetary system, which is dominated by the US dollar. The immediate trigger of the crisis

was the bursting of the US housing bubble in 2007. In 1971, the USA unilaterally walked

away from the Bretton Woods System (BWS), which, known as the Nixon Shock, caused

*Gang Fan, Director, National Economic Research Institute, Beijing, China. Email: neri2@neri.org.cn;

Bijun Wang, Research Fellow, Institute of World Economics and Politics, Chinese Academy of Social

Sciences, Beijing, China. Email: wangbijun007@126.com; Yiping Huang, Professor, China Center for

Economic Research, Peking University, Beijing, China. Email: yhuang@ccer.edu.cn.

15

A Proposal for Asia to Deal with the Global Reserve Risks

©2013 The Authors

China & World Economy ©2013 Institute of World Economics and Politics, Chinese Academy of Social Sciences

the breakdown of the BWS. Since then, a growing consensus has been formed among

economists, practitioners and policy-makers regarding the need to reform the global

monetary system. One key reform that has been proposed is to reduce the dependence of

the global monetary system on the US dollar as the reserve currency (UN Commission,

2009; Sachs et al., 2010).

However, constructing a new monetary system is a challenging task. Those who have

vested interests could stand in the way of reform. The current international monetary

system and regulations are not only the results of negotiations, but represent the will of

powerful agents. Since the Second World War, the US dollar has played a dominant role in

the international monetary system because the USA has had incredibly strong economic

power, and possesses the most advanced market and financial system worldwide. During

the Second World War, 60 percent of the world’s gold was stored in the USA, which meant

that the US dollar held firm. The USA does not want its currency status to be challenged,

and certainly is aware of the problems that the current system imposes on other countries.

One important characteristic of the post-BWS regime is global monetary asymmetry.

Two groups of economies have been formed: a small group of developed countries as the

issuer of reserve currencies and a large group of other countries as the user of these

currencies (Fan, 2006). After the Second World War, the US dollar became the dominant

global reserve currency, placing the USA in a special position in the global monetary

system. Consequently, the Federal Reserve plays a unique role in providing liquidity to the

global economy. The mismatch between national mandate and global responsibility is an

important factor contributing to post-BWS global financial bubbles.

Among economists, there are differing views on the future evolution of the global

reserve system. One stream believes that, despite the widespread concerns over the dollar’s

future, there is no alternative currency to substitute the US dollar and become a reserve

currency in the perceivable future. This implies business-as-usual in the coming years.

Another group focuses on creating a true global currency to overcome the shortcomings

highlighted by the Triffin dilemma; that is, when a national currency is used as a global

reserve currency, the foreign demand for this reserve currency forces the issuing country

to run persistent current account deficits, eventually leading to a reluctance of creditors to

hold the reserve currency; after all, a persistent trade deficit inevitably results in declining

value and credibility of any currency. The idea of creating a true global currency was

revived by the People’s Bank of China (PBOC) Governor Zhou Xiaochuan and was later

echoed by the UN Commission on Financial Reforms (UN Commission, 2009; Zhou, 2009).

However, neither continuation of the status quo nor creation of a global currency has been

determined to be a feasible solution to the existing problems; therefore, a third group

advocate diversifying the global reserve system.