March 24, 2009: For years anyone who wanted to buy gold, oil or securities on world markets usually wound up paying his bill with the U.S. dollar, regardless of what currency his own country used. The dollar has been the world's leading reserve and trading currency since World War II. As a result of the worldwide financial crisis, the dollar's position is being challenged – openly. The head of the Chinese national bank, Zhou Xiaochuan, is suggesting that the world's currency system needs to be reformed, with the dollar being replaced as the dominant currency.

According to Xiaochuan, America could afford to have low interest rates domestically because there has been no real option for foreigners to buy securities in large volume other than from the American government. The availability of cheap funding led to the speculative bubble in the housing market, which in turn brought about the ongoing financial crisis. Analysts described Xiaochuan's comments as being tantamount to a lecture for Washington on its failed monetary policy.

Russian officials have also voiced their concern about the dollar's weakness. With the U.S. government using the printing press to combat the recession, their concerns are easily understood. Dollar inflation will be a likely result of President Obama's economic stimulus package, so foreign consumers will help pay the bill for America's recovery, and Chinese currency holdings will be devalued. The Chinese hold nearly two trillion dollars in U.S. Treasury securities and currency, and despite its efforts to reduce its dollar holdings, Russian vaults still show a balance of some 380 billion dollars, making the country the third largest owner of dollars worldwide.

If the dollar were to be replaced by a single currency, it would be the euro. In the ten years since its initial introduction as a bookkeeping value, the euro has advanced to become the world's second reserve currency, with some 28 percent of the world's reserves. However, the Chinese do not appear interested in having the dollar replaced by the euro or any other currency. Instead, they want to see the "Special Drawing Rights" (SDR) value of the International Monetary Fund (IMF) used as the world's reserve currency. The SDRs are an artificial value made up of a basket of currencies containing the dollar, euro, pound sterling and the yen. The ratio of the four currencies is regularly adjusted by the IMF and reflects their relative value within the world's system of trade and monetary exchange.

Experts were initially surprised by China's call to have SDRs replace the dollar as the world's main currency of exchange. SDRs are only a bookkeeping value used by the IMF in granting financial aid. However, one advantge to using them instead of a single currency would be a greater measure of currency stability, since the fluctuation in one currency's value within the "basket" would be less than the single currency itself. For a country heavily dependent on exports like China, having stable exchange rates is a crucial factor in marketing products internationally.

If China's suggestion were to be implemented, it would mean a reintroduction of fixed exchange rates for the world's major currencies. Establishing fixed exchange rates would likely win little support, however – especially if the exchange rate was based on an artificial value like IMF SDRs instead of a real currency. The most likely scenario is the continued erosion of the dollar's position as the world's main reserve currency. The Chinese challenge is significant, especially following the visit to Peking by new U.S. Secretary of State Hillary Clinton last month, when she assured Chinese leaders that it was safe for them to invest in U.S. Treasury securities. The currency that will benefit the most by the dollar's weakness is the euro, which just celebrated its tenth birthday.