Zhou recommended replacing the IRC function of the dollar with Special Drawing Rights (SDRs), a composite currency --an international reserve asset -- created by the IMF in 1969. Others, including the Nobel Laureate economist Joseph Stiglitz and a UN panel of experts, have also favoured the idea.

THE international reserve currency (IRC) of preference is the US dollar. By an IMF estimate, 64% of the world's reserves are held in dollars, followed by 26.5% in euro, 4.1% in British pound, 3.3% in Japanese yen. and all others2.1%.

However, the sustained downward drift of the dollar against six other strong currencies since it peaked at 89.11 on March 5 has become a concern. On November 25, for example, the dollar index had slipped to 74.23 - its lowest point in more than a year. The weakening dollar, nonetheless, is making US exports more competitive and imports more expensive to the glee of American manufacturers. Tourists from across the Atlantic are also cheering while shopping

in America's malls.

China, Russia, Japan, India, among others, who re holding massive dollar reserves are concerned about huge losses if the U.S. bailout and stimulus packages, burgeoning budget deficits (projected to reach 13.5 % of GDP this year) and of course, the issuance of 1.3 trillions dollars of additional currency by the US Fed generate high inflation and eventual dollar devaluation.

In a March 24 article, Zhou Xiaochuan. governor of China's central bank has floated the idea of creating a supersovereign IRC - one that is "disconnected from individual national currencies and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies."

Zhou recommended replacing the IRC

function of the dollar with Special Drawing Rights (SDRs), a composite currency - an international reserve asset -- created by the IMF in 1969. Others, including the Nobel Laureate economist Joseph Stiglitz and a UN panel of experts, have also favoured the idea.

Today's build up of dollar reserves by many countries is a repeat of what happened for 15 years into the operations of the Breton Wood fixed exchange rate (BWS). Reserve currencies were stockpiled in the process of limiting the appreciation of domestic currencies from continued trade surpluses and foreign financial inflows. These reserves then acted as shock-absorbers, restraining short-term disruptive shocks of unexpected trade shortfalls and transitory outflows of forex. Countries lacking such reserves either had to let their currencies depreciate or resort to contractionary monetary policies which, at times, were inconsistent with domestic price stability and output growth.

Pessimism with the dollar and appeal for the SDRs isn't new. Just like today, countries with stockpiles of dollar reserves became concerned about incurring heavy losses from potential dollar devaluation. Then, it was France which sought to replace the dollar with an IRC

unrelated to a single national currency.

The IMF then came up with the SDR --defined as equivalent to 0.888671 grams of fine gold which, at the time, was also equivalent to one U.S. dollar. To begin with, the IMF issued 9.3 billion SDRs between 1970 and 1972 and apportioned them to member countries in proportion to their IMF quotas.

After the collapse of the BWS in March 1973, major developed countries adopted the floating exchange rate (FXR) system -letting their currencies float against the dollar - ending the expediency of building dollar reserves. The IMF then redefined the SDR as a weighted average of the US dollar (0.44), the euro (0.34), the British pound (0.11), and the Japanese yen (0.11). The SDR is calculated as the sum of specific amounts of the four currencies valued in US dollars.

In practice, the SDR is neither a currency nor a claim on the IMF. Rather, it's a potential claim on the freely usable currencies of IMF members. Although the SDR exhibited more stability vis-i-vis other currencies than the dollar, thus exposing a country's reserves with less XR valuation risk, the SDR hardly got off the ground as IRC.

In a bid to revivify the SRD, the IMF made a second allocation of 21.4 billion between 1979 and 1981, which again

failed to impress any country as IRC since, by then, the developed countries had already settled down with the FXRs as the standard. The SDR primarily performed the function of unit of account in the IMF book.

Why does the dollar continue to reign? Global trades of good and services among countries are typically priced and paid in dollars -- including many financial instruments. Invoicing them in a single currency helps producers easily adjust their prices in line with their competitors and facilitates price comparisons across the different producers.

Even in goods where pure price competition isn't vital for trade, home currency is first used to buy dollars, which in turn are used to buy exporters' currencies to consummate the payment. The dollar, despite substantial fluctuations over the years, has maintained this role conveniently and at substantial cost savings to all concerned. In short, a strong and open US economy and the financial system helped facilitate the dollar s international use.

A 2007 survey indicated that nearly $3.2 trillion worth of forex trades changed hands each day, and 86% of those transactions involved dollars. These traders finance a large portion of their business in dollars, requiring maintaining accounts

in dollars, seeking loans in dollars, and undertaking multitudes of other financial arrangements in dollars.

Leaders of at the G-20 meetings in London revisited the IRC issue and decided to authorise the IMF to increase the SDR allocation from its previous level of 21.7 billion to 204.1 billion by September 9, 2009. Professor Stiglitz hailed it as a "major step” towards establishing the SDR as an IRC.

But, replacing the dollar with the SDR as the key IRC isn't happening any time soon -- not until the SDR matches the myriad of benefits people across national boundaries have been reaping for years. Besides, a large number of countries and people must make the switch to SDR in concert. Meanwhile, the countries that are concerned about their exposure to credit-based reserve currencies, like the dollar, might simply allow their currencies to appreciate.

If, one day, the SDR establishes itself as the IRC, "the dollar would live on in an SDR-dominated world. It would no longer reign supreme, but neither would the yen or the euro or the yuan, which might be the best long-run outcome the US can hope for (Time, April 9)."

Dr. Abdullah A Dewan. founder of potibconomy com. is a Professor of Economics at Eastern Michigan University.