Will Strauss-Kahn’s Fall Lead to the Dollar’s Decline?

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There’s a lot of talk about what Dominique Strauss-Kahn’s arrest for sexually assaulting a maid means for the eurozone crisis. Less attention has gone to the fate of another project close to DSK’s heart: weaning the global financial system off of the U.S. dollar. DSK had been a vocal proponent of using the IMF’s de-facto currency, the Special Drawing Right, as a way to diversify countries’ reserve pools away from the U.S. dollar.

There are a lot of technical hitches and drawbacks to making the SDR the world’s only reserve currency. But the idea of expanding the role of SDRs as one among several global currencies has slowly gained traction as more emerging economies like Brazil and China voice their support. Their backing is partly a way to chide U.S. officials for abusing the dollar’s dominance through loose monetary policy (which stokes inflation in emerging markets) and overspending (which undermines the dollar’s value for foreign holders).

Whoever takes the helm at the IMF will have to contend with this issue sooner rather than later, since the stability of the world’s financial system lays in the balance. A new report out today from the World Bank says that, due to the rise of emerging markets, the world will inevitably move away from a single currency system dominated by the dollar by 2025.

The most likely replacement? A multi-currency system in which the dollar shares the global stage with the renminbi, the euro, and possibly the SDR. Of course there are naysayers who still think the dollar will remain the only viable option for decades to come, especially in light of the euro’s recent plight. But the dollar’s share of foreign exchange reserves is already declining.  Between 2000 and 2009, the proportion of reserves held in dollars declined from 71% to 62%, whereas the share of reserves held in euros increased from 24% to 27% over the same period.

That trend will accelerate as emerging economies grow faster than those in the developed world. The World Bank report estimates emerging market growth will more than double the pace of advanced economy growth between 2011 and 2025, which in turn will funnel an increasing portion of the world’s foreign exchange holdings to those bigger markets. Already emerging and developing countries’ share of the world’s $9 trillion in official foreign exchange reserves has risen from 37% in 2000 to two-thirds last year. As their foreign exchange reserves grow, emerging economies will be more motivated to scrap a dollar-dominated system for one that offers less risk and more payoffs to the world’s new economic powerhouses. That’s because countries with internationalized currencies benefit from lower borrowing costs, a leg up in financial markets, and more room to set independent monetary policies.

No wonder then that the U.S. is keen to maintain its role as the world’s only global reserve. But don’t mistake U.S. rhetoric or calmness in the bond markets over U.S. debt for the dollar’s eternal sanctity. Right now the dollar’s strength is riding on its liquidity, ubiquity, and concerns over the euro’s fate. It’s also riding on the U.S.’s long-held sway in global fora like the IMF and G20, which has kept a revamp of the global financial system low on their agendas. But those days are quickly coming to an end. Recent G20 meetings have shown that emerging market leaders are ready to push much harder against the insular financial interests of the U.S. Already they are calling for DSK’s successor at the IMF to be one of them. Should that happen, the end of the U.S. dollar’s reign may come even sooner than we think.