Le·gal In·sur·rec·tion

It is amazing how this administration creates controversies because it expresses opinions without reading the documents on which the opinions are based. First, there was the AIG bonus controversy. The bonuses were authorized by the stimulus plan, which neither the administration nor Congress actually read before signing.

Now it is Secretary of Treasury Timothy Geithner's opinion that he might be open to a Chinese proposal to create a new international reserve currency. In a post titled Geithner 'open' to China proposal, Ben Smith at Politico reports as follows (emphasis in quotation mine):

Geithner, at the Council on Foreign Relations, said the U.S. is "open" to a headline-grabbing proposal by the governor of the China's central bank, which was widely reported as being a call for a new global currency to replace the dollar, but which Geithner described as more modest and "evolutionary."

"I haven’t read the governor’s proposal. He’s a very thoughtful, very careful distinguished central banker. I generally find him sensible on every issue," Geithner said, saying that however his interpretation of the proposal was to increase the use of International Monetary Fund's special drawing rights -- shares in the body held by its members -- not creating a new currency in the literal sense."We’re actually quite open to that suggestion – you should see it as rather evolutionary rather building on the current architecture rather than moving us to global monetary union," he said.

The reason there is a controversy, is that the actual statement by the Chinese, which Geithner did not read, did call for the creation of a new currency, which would be an amalgam of numerous national currencies, to be used as a reserve:

The desirable goal of reforming the international monetary system, therefore, is to create an international reserve currency that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies.

The Chinese made clear that they were calling for a new currency, a so-called "super-sovereign" currency, to replace the dollar at the world's reserve currency:

Though the super-sovereign reserve currency has long since been proposed, yet no substantive progress has been achieved to date.

The effect of having a super-sovereign currency would be that all nations, including the United States, would have to use this currency for international transactions. As the The Financial Times explained:

China’s proposal would expand the basket of currencies forming the basis of SDR valuation to all major economies and set up a settlement system between SDRs and other currencies so they could be used in international trade and financial transactions.

Similarly, the Wall Street Journal explained the implications:

China called for the creation of a new currency to eventually replace the dollar as the world's standard, proposing a sweeping overhaul of global finance that reflects developing nations' growing unhappiness with the U.S. role in the world economy.

So yes, there would be a new currency used for international transactions, contrary to Geithner's uninformed opinion which downplayed the implications, which is why the stock and currency markets are in flux as we speak. Geithner now has clarified his comments in an attempt to ease market concern.

Will someone please tell Tim Geithner to read the document, before he picks up the phone.

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UPDATE: This article in the March 26. 2009 Wall Street Journal sums up the problem of Geitner embracing what the WSJ calls a new international reserve currency:

The dollar's status as a reserve currency gives the U.S. enormous advantages, and it should be protected ferociously by our public officials. It means we don't have to repay our debts in foreign currency and that our borrowing costs are cheaper. To the extent that the rest of the world follows a dollar standard, it also gives us far greater global sway.

It is this influence that Russia, China and others sometimes resent and would like to see displaced. The problem is that there really isn't an obvious successor to the dollar. No other economy is large enough, with deep enough capital markets. The euro might become an alternative down the road, but it remains too new and lacks the necessary underpinning of political cohesion.

Yet Mr. Zhou's demarche is also a warning that reserve currency status carries special obligations. It means the U.S. isn't conducting monetary policy only for itself but for much of the world. And it means that when the U.S. falls for the temptation to debase its currency, it sends shocks through the entire global trading system.