And the US dollar reserve currency system the backbone of the current global financial system is fraying.

But China is likely to increase its voice on one issue the US dollar s status as global reserve currency.

The Federal Reserve and the Currency Wars

The first is the need for a truly global reserve currency, perhaps based on the IMF Special Drawing Rights (SDRs).

The deficiencies of current arrangements are why the world monetary system should be based on a truly global reserve currency a fiduciary currency backed by the world s central banks.

Sarkozy s rhetoric suggests that he hankers after new international agreements on exchange rates, and, indeed, perhaps a new global reserve currency.

At the international level, the standing of US supplied public goods (including the dollar as the global reserve currency) faces gradual erosion.

This would overcome both the inequities and the instability that is inherent in a global reserve system based on a national currency.

This is particularly true of the quantitative easing now underway in the United States, because the American dollar is the major global reserve currency.

ITHACA Scarcely a week passes without news about the ascendance of China s currency, the renminbi. But China has a long way to go before its currency can rival let alone displace the US dollar as the dominant global reserve currency.

The currency peg has also helped make the euro into an important reserve currency, rivaling the dollar.

China s renminbi is internationalizing, but its share of global payments remains relatively small, with the dollar retaining its role as the world s main reserve currency.

Many proponents of the euro claimed that it would quickly evolve as an alternative reserve currency alongside the dollar, or even replace it, in global markets.

Europe has come a long way from the days when its leaders prophesied that the euro would quickly rival the dollar as a global reserve currency.

Of course, developing as a potential reserve currency created a substantial vulnerability.

A global system for prudential regulation and supervision a revamped IMF managing a global reserve currency, coordinating global macroeconomic policy, and providing agile credit lines and an international debt court all of these must be on the agenda.

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.

The euro is also a global reserve currency (albeit of secondary importance), but most eurozone governments financing costs are much higher than what the US Treasury pays.

And a United Nations advisory committee chaired by the Nobel laureate Joseph Stiglitz has argued for a new global reserve currency, possibly one based on the SDR.

Reserve Sterling is used as a reserve currency around the world and is currently ranked 3rd in value held as reserves.

The implication is that the dollar, the euro, and the renminbi will share the roles of invoicing currency, settlement currency, and reserve currency in coming years.

In the 1960 s, the British pound was the world s second reserve currency.

And, while there is general unhappiness with the US dollar, the Chinese renminbi is still far from becoming a major global reserve currency, let alone the dominant one.

The US and Japan might be among the last to face the wrath of the bond market vigilantes the dollar is the main global reserve currency, and foreign reserve accumulation mostly US government bills and bonds continues at a rapid pace.

The alternative, as China has suggested, would be to develop a new reserve currency.

Lukashenko may have to adopt the Russian ruble, at least as a reserve currency.

The European Monetary System began as a high level reaction to global currency chaos, and in particular to the depreciation of the dollar in 1977 and 1978, which seemed to threaten its continued role as the major international reserve currency.

Third, a global reserve system is needed.

It then cites global current account imbalances, particularly the US external deficit, describing it as unprecedented for a reserve currency country to have a current account deficit of such magnitude.

And, as a provider of a reserve currency, China would not need to continue its own quest for reserves, which has been a major contributing factor to global financial instability.

And the dollar could still remain the preferred reserve currency, provided it is prudently managed.

Finally, as a step toward making the renminbi a reserve currency, China signed currency swap agreements with the Philippines, South Korea, Japan, and Australia.

The dollar reserve system is fraying, but is likely to be replaced with a dollar euro or dollar euro yen system that is even more unstable. Annual emissions of a global reserve currency (what Keynes called Bancor, or the IMF calls SDRs) could help fuel global aggregate demand, and be used to promote development and address the problems of global warming.

In the nineteenth century, the stable hegemon was the United Kingdom, with the British Empire imposing the global public goods of free trade, free capital mobility, the gold standard, and the British pound as the major global reserve currency.

BERKELEY The competition for reserve currency status is conventionally portrayed as a winner take all game.

The euro s becoming a major reserve currency bestows important economic advantages on the euro zone economy.

But, even under floating exchange rates, the US retained an advantage given that the dollar remained the key global reserve currency, the US could finance large external deficits at very favorable rates.

Global integration of China s financial sector will require opening the capital account, which will have to be carried out steadily and with considerable care but it will be a key step toward internationalizing the renminbi as a global reserve currency.

Meanwhile, to avoid exchange rate conflict, the US Federal Reserve typically stays out of the currency markets.

Since a country s currency can be a reserve currency only if others are willing to accept it as such, time may be running out for the dollar.

Because many countries have been consolidating simultaneously, interest rates are already low and, for the US, which accounts for more than 20 of the global economy and issues the global reserve currency, caution in generalizing from other fiscal episodes is highly advisable.

But skeptics question whether the SDR could ever replace the dollar as the world s leading reserve currency, for the simple reason that the SDR is not a currency.

Third, the renminbi s international and reserve currency prospects will be shaped by how China handles its growth slowdown.

Reserve accumulation was also a by product of China s deliberate currency undervaluation to promote export led growth strategy.

Moreover, global currency markets would be disrupted, and the global economy would deteriorate.