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Russian determination to displace dollar as reserve currency unflagging

Posted by Kris Roman on July 8, 2009


Over half of the Earth’s population was represented in summit meetings in Yekaterinburg this week. BRIC (Brazil, Russia, India and China), the world’s largest emerging economies, convened a summit in the Russian city simultaneously with, but separately from, the ninth Shanghai Cooperation Organization summit on Tuesday, June 16. China, Russia, Kazakhstan, Kyrgyzstan, Tajikistan, and Uzbekistan are the permanent members of the SCO. Mongolia, Pakistan, India and Iran are SCO observer states, with Iran an applicant for full membership.

The United States loomed large at the summits, as the leaders from three continents declared the superpower’s influence waning and discussed international issues independently from the West, including the introduction of new reserve currencies. Bumping the dollar out of its dominant position in world economics, and using the ruble to do so, is a fondly-held Russian ambition. “We are likely to witness the creation of a supranational reserve currency… which will be used for international settlements. The existing currency system is not ideal,” Russian President Dmitry Medvedev stated Tuesday in Yekaterinburg, as quoted by Reuters.

Russia began its drive against the hegemony of the US dollar before the Group of 20 summit in London in April of this year. Russia proposed creating a supranational currency based on the ruble and the Chinese yuan. “Today’s system is inadequate and holds too many risks connected with the unilateral actions of the small number of countries responsible for issuing reserve currencies,” Russian presidential advisor Arkady Dvorkovich told a press conference in March. The Chinese endorsed Russia’s stand. The G20 refused to consider it, but Russia made it known that the world was to hear more on the topic.

Indeed, Medvedev restated his intentions the following month after a meeting with Italian Prime Minister Silvio Berlusconi, who will host the G8 summit in July. “We are not dropping the idea,” he added.

The idea is not without merit. Besides politically-motivated arguments about “risks connected with unilateral actions,” the dollar’s status as main reserve currency is made problematic by the huge and ever-growing US debt, which undermines the currency’s stability and viability. A panel discussion was held on reserve currencies at the St. Petersburg Economic Forum earlier this month. International Monetary Fund first deputy managing director John Lipsky admitted there that “There are many, many attractions in the long run” to the replacement of the dollar as the global reserve currency. Bloomberg cites IMF statistics indicating that the dollar accounted for 64 percent of central bank reserves at the end of 2008, up from 62.8 percent in June 2008.

The weightiness of Russia’s proposal was underscored by fluctuations in the dollar’s exchange value before and during the Yekaterinburg summits. The currency reversed its trend and rose 0.5 percent on the benchmark ICE dollar index Monday when Russian Finance Minister Alexey Kudrin stated at a meeting of G8 finance ministers that “It’s too early to speak of an alternative” to the dollar as a reserve currency. That gain was lost the following day after Medvedev’s statements and the BRIC summit communiqué, which called for “a stable, predictable and more diversified international monetary system.”

Russia proposed the ruble, yuan and gold be included in a new basket for IMF special drawing rights. In addition, Russia stated that it would reduce its reserve holdings of US Treasury bonds by $10 billion and buy IMF bonds denominated in special drawing rights in their stead. China and Brazil also expressed intentions to increase their purchases of IMF bonds, in a bid for more influence in that organization.

Special drawing rights are the currencies used by IMF members to peg the values of international financial instruments and some currencies and for international settlements such as postal agreements and liability settlements. The addition of gold to the special drawing rights basket is a serious transformation. The unit was created to take the place of gold and silver in international transactions after the postwar Bretton Woods system of international monetary relations collapsed in 1971, when the US went off the gold standard. When the US unilaterally abandoned the gold standard, the US dollar became the de facto reserve currency for the countries that adhered to the system.

The final statement issued by the SCO summit does not contain any mention of new reserve currencies or even “modernization of the financial architecture,” a Moscow catchphrase for revising international finances. But this is a case of actions speaking louder than words. At the SCO summit, China announced a $10-billion program for investment in Central Asia. According to Kommersant, that money will be invested there, not loaned.

Then, on Wednesday, Chinese President Hu Jintao met with Russian Prime Minister Vladimir Putin and with Medvedev, after which “the deal of the century” was announced – a $100-billion energy agreement to be settled in rubles and yuan. The agreement encompasses gas, oil and electricity and the technology associated with them.

Nonetheless, Kudrin’s pronouncement that the dollar is still firmly entrenched in the international exchange system remains true. The BRIC countries’ economies account for 15 percent of the world economy. China has $767.9 billion in US Treasury bond holdings, Reuters notes. Bloomberg’s Laura Cochrane and Lester Pimentel note in a detailed article that the BRIC countries’ dollar bonds perform better than those in their local currencies, and ruble- and yuan-denominated bonds are not freely tradable. The BRIC leaders did not discuss buying each other’s bonds, Bloomberg stated, citing Brazilian President Luiz Inacio Lula, although Brazil and China will begin settling their mutual trade in their own currencies as well.

Nor are the local markets in those countries particularly attractive to foreign investors. Besides restrictive legislation, foreign investors in Russia are likely to keep the recent “gas wars,” the Yukos scandal, the 1998 Russian financial crisis, the hyperinflation earlier in that decade and innumerable political issues in mind. None of that adds to the draw of the ruble in the West.

“It’s not up to politicians to determine which currency will be the world reserve currency,” Lutz Karpowitz of Commerzbank AG in Frankfurt told Bloomberg. “In the end the market decides it.” If Russia can implement its political will in market reforms, and China continues on its course to overtake the US economy within two decades, the world market may look considerably more diverse than it does today. The dollar will undoubtedly still have a place in it.

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