Recent experience with the euro as an official reserve asset is instructive.

The dollar has lost what any reserve asset should have a stable value.

A better idea is to start work now on creating a more attractive global reserve asset.

After all, it is the liquidity of US Treasury bonds that makes them the world s leading reserve asset.

This is plausible in terms of a future decline in the dollar s importance as a reserve asset and safe haven.

Revaluation would accelerate this trend.

Revaluation of the Chinese yuan would also help.

Simply put, the global economy has at its center a dysfunctional political regime that generates recurrent threats of default on the world s major reserve asset.

The outside world, which relies on the dollar as its primary trade vehicle and therefore reserve asset, cannot be expected to watch passively as dollars continue to pour into their currency, commodity, and asset markets, with no clear end in sight.

This obvious externality required policy responses in the emerging countries limits on capital inflows, reserve accumulation, and measures to restrict credit and restrain asset price inflation.

The better known consequence has been deepening uncertainty about the US dollar, the main global reserve currency, and US Treasury securities, supposedly the world s safest financial asset.

In order to make the SDR the principal reserve asset via the allocation route, close to 3 trillion in SDRs would need to be created, an unrealistic proposition.

But it seems that both revaluation and reform will take time.

An independent monetary policy requires a flexible exchange rate, not a revaluation.

Moreover, unlimited quantitative easing by the Bank of Japan, the Federal Reserve, and the European Central Bank also increases the risk of volatile capital flows and asset bubbles in Asian emerging economies.

So, instead of becoming the principal reserve asset of the global system, the proportion of SDRs in global reserves shrank to a tiny fraction, rendering the SDR the monetary equivalent of Esperanto.

Second, it increases global asset demand, generating asset price inflation.

Whether they stand to gain or lose from a renminbi revaluation, however, is hotly contested.

The asset that is purchased need not be a physical asset.

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Asset recovery

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Such a revaluation would also discourage exports and encourage imports, thereby reducing China s chronic trade surplus.

Japanese intervention cannot explain the revaluation of the euro against the dollar and many other currencies.

It undertook a small revaluation in 1969 and then let its currency float in May 1971.

Gains arising from the revaluation of non euro cash and bank amounts are treated as realized

The SDR was introduced 40 years ago to supplement what was then seen as an inadequate level of global reserves, and was subsequently enshrined in the IMF s amended Articles of Agreement as the future principal reserve asset.

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Yes, further revaluation of the exchange rate is needed, but this can play only a secondary role.

China, however, refused to accept the blame and declined repeated US demands to undertake a large revaluation.

But would a revaluation of the renminbi solve America s problems? Recent evidence suggests that it would not.

The following analysis is presented at 2006 2007 costs, i.e. including the element of revaluation and recosting.

Of this amount, 386,000 is attributable to the revaluation of the outstanding loan from the United Nations.

The establishment of SDRs was accompanied by a commitment, included in the IMF Articles of Agreement, to making the special drawing right the principal reserve asset in the international monetary system (Article VIII, Section 7 and Article XXII).

Chinese government debt will become an important global benchmark asset, which should help its private sector to attract funding on reasonable terms, while the predominance of the US Federal Reserve in determining worldwide monetary conditions would presumably diminish.

Under these circumstances, revaluation of the exchange rate will not have a severe impact on an economy s development.

However, unlike Japan, China will not accede to calls for a sharp one off revaluation of the renminbi.

China interprets quantitative easing as a plot to devalue the dollar and force a revaluation of the renminbi.

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(f) Operating reserve

Mission Reserve Battalion