The international monetary system has been in need of fundamental reform. It is dominated by dollar holdings, with the American currency remaining the world's principal reserve currency as well as the most widely used in private transactions. The dollar, which faced many challenges, has remained supreme mainly for want of an alternative. A recent G20 seminar held in Nanjing, China, ended without any consensus on international monetary reform. The stasis is unfortunate. The system may not have caused the recent global imbalances or current instability in the global economy, but it has certainly been ineffective in addressing them. First, it has created a global recessionary bias both during and after financial crises. Secondly, there is a certain amount of tension in using a national currency as a reserve. The U.S. has been running huge budgetary and current account deficits. Should it succeed in reining in the deficits, global liquidity would shrink. Thirdly, the system has encouraged large dollar accumulations by several countries by way of “self-insurance” against future crisis. The very large dollar holdings by China and some other countries have added to global imbalances.

Various attempts at identifying alternative reserve currencies have floundered. The euro seemed promising at one time but the current debt problems in some euro zone countries have raised doubts over its long term suitability. Given the strength of China, the yuan is bound to become an important reserve currency in course of time, freely convertible and with an exchange rate mirroring its growing clout. Some out-of-the-box solutions are required. Nobel laureate Joseph Stiglitz has, in a recent article in the Financial Times, suggested that the SDRs issued by the International Monetary Fund should play a greater role in the international monetary system. SDRs, which are strictly the IMF's unit of account, represent a potential claim on other countries' freely usable currency reserves, for which they can be exchanged voluntarily. The specific proposal is to issue a significant amount (up to $390 billion) of new SDRs every year for the next three years. Central banks can exchange the SDRs for hard currency and use it to finance imports. The inherent recessionary bias in the existing system is thus avoided. Being relatively small, the new issues will not accentuate global imbalances. The effectiveness of the SDRs ought to be enhanced through a variety of measures, which are inextricably linked to IMF reform. The medium-term goal is to make SDRs the main, or even the only, means of IMF financing. The dollar's pre-eminence in private trade and remittances will remain unaffected.

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