SINCE the World War II, global monetary affairs have been dominated by the dollar, which is held internationally and the US benefits from its seignorage gains (gains made by governments from printing money). High international demand for the dollar reduces the real yields that the US government has to pay on its debt, thus providing that government with such gains. The role of the US in such a scenario is simple. The US Fed prints dollars which it ‘exports’ to buy real goods and services in return. These dollars can only be invested in US assets inside the country and when spent outside the US, they do not cause domestic inflation (in the US). The continuous flow of foreign investment due to this mechanism bolsters the US capital account and has allowed the nation to run a trade deficit without devaluing the greenback.

The US trade deficit has been around five per cent and the foreign debt at 60 per cent of the GDP. These statistics clearly indicate the benefits that the US enjoys based on the dollar being the dominant reserve currency and as a dominant vehicle currency in trade.

If OPEC were to abandon the dollar for some other currency, the whole process of US supremacy (in terms of producing dollars to get real goods and services in return) would be defunct. Corporations and central banks would sell their dollar reserves, causing the value of the dollar to fall sharply.

Additionally, investors will sell the assets in which dollars are invested. The excess supply of dollars in the local market would lead to runaway inflation. The US would no longer be able to run huge trade deficits and would in fact have to export real goods and services to accumulate the new reserve currency or a portfolio of reserve currencies (dependent on the new international reserve currency framework).

The falling dollar: The European Union has an edge over the US (in relation to Opec and the preferable currency issue) in the following areas:

* The EU has a bigger share of world trade than the USA;

* Its oil import bill is larger than the USA; It is the main trading partner of the Middle East;

* It offers higher interest rates than the US;

* The EU does not run a trade deficit and does not have a huge foreign debt like the United States.

Additionally, over the past few years the following major deviations in the global trade market have been observed that indicate a move away from dollar dominance:

* In 2002, China started converting some of its currency reserves from dollars to euros;

* North Korea abandoned the dollar and started using euros for trade;

* Iran (Opec member) converted most of its currency reserves to euros during 2002, and a proposal to price Iran’s oil in euros has been considered by the central bank and the parliament;

* At the Opec summit (September 2000), José Chavez recommended that Opec set up a high-tech electronic barter system, under which the members could trade oil for goods and services without the use of dollars or any other currency. In this regard, Chavez made 13 barter deals;

* In October 2000, the former Iraqi (Opec member) President Saddam Hussain had decreed that Iraqi oil would be sold for euros instead of dollars, with effect from November. Soon afterwards, Saddam converted Iraq’s entire $10 billion oil reserve fund from dollars to euros.

The dollar of late has lost its value substantially against major international countries. Since 2000, the dollar has depreciated about 43 per cent of its value against the euro and around 30 per cent against the yen. These statistics clearly show that the dollar has weakened considerably over the past 4-5 years.

In fact, the dominant reserve currency should be a strong stable currency which the dollar was prior to this weakening in the past few years. This has undermined the dollar’s status as the dominant reserve currency and thus has forced central banks to move towards other currencies and asset backed securities. Additionally, the US has been running huge trade deficits.

Recently, the US Commerce Department reported a trade deficit of $60 billion (which is an all-time record). The US is a net foreign debtor as opposed to the net foreign creditor which should be associated with a country whose currency is being used as the dominant reserve currency.

In light of the dollar’s weak performance in the recent past and strengthening of the Chinese economy and the European Union, there is the need to move towards a multiple currency system. There is a 90 per cent negative correlation between the value of dollar and the gold prices. There should be a basket of reserve currencies. Simply put, it is applying portfolio management to diversify risk for the central banks. The dollar weakening has further supported earlier claims that there should be considerable diversification of currencies in the central banks’ reserve portfolio.

Based on the present composition of trade, performance of economies and the value of currencies the basket should entail the euro, the dollar and the yen. In the near future, as the presence of the Chinese economy grows in the world market, the Yuan could be added to the basket. The respective share of each currency in a central bank’s portfolio would depend on the trade pattern of a particular country and the discretion of the policy makers.

Based on the fact that the EU has a bigger share of world trade than the US, its imports more oil than the USA and is the main trading partner of the Middle East, the Euro could have the greatest weight in the central banks portfolio of reserves.