It may not be the top subject of discussion around the average family dinner table, but China's Nov. 30 entry into the International Monetary Fund's Special Drawing Rights (SDR) currency basket marks the start of a new era in the global economic structure. The accession will not immediately bring about seismic changes in the yuan's usage, rocketing it up to international reserve currency status in one glorious surge. That kind of usage growth, if indeed it ever does happen, will take years to come about. The more immediate change is actually subtler and has more to do with what China is - or more specifically, what it is not. The yuan has become the first SDR basket currency to belong to a country that is not a clear U.S. ally - the other slots are filled by Japan, the United Kingdom and the eurozone. This is important because it is part of a wider trend, reflecting increased economic power in new parts of the world. The IMF (along with the World Bank) is the key institution of the world order that was designed by the United States and its allies at Bretton Woods in 1944. The IMF's including the yuan in the SDR coincides with an attempt to reform this system in favor of these new powers - an attempt that the United States has stalled with a veto for five years. The important question, then, is how the United States, as the architect and leader of the existing system, will cope with these new challenges.
Origins of the SDR
But before we get into the Nov. 30 developments, it is important to first understand the basis of the current system. When the United States crafted today's economic order at Bretton Woods in 1944, it was acting, as is so often the case, with an eye toward avoiding the mistakes of the past. The United States is blessed with the most favorable real estate and geographical positioning of any country in the world, with extensive fertile lands and river systems, access to both major oceans and sizable barriers against any major threats. But these gifts have been both a blessing and a curse, for while they enable immense productivity, and hence power, they also create a temptation toward isolationism; Americans tend to retreat behind their ocean buffers and enjoy their continental paradise. This temptation was so strong that for the first 150 years of its history, the United States did exactly that - fighting engagements to protect trade routes and secure its own strategic position, but rarely interfering in the politics of other continents. It was forced out of this comfortable position by World War I and again by World War II. By 1944, the lesson the United States had learned was that it needed to be present to prevent these situations from arising in the first place, and the most sensible strategy was to exert its own power to block the rise of any single large challenging bloc or competitor. With some estimates putting U.S. gross domestic product at 50 percent of the world share in 1945, the United States was in a position to do so.
The resulting global order was quite a departure from the one it replaced largely because of the differences between the United States and the United Kingdom, its predecessor as global hegemon. By surface area, the British Isles are a 30th the size of the United States. The British Empire's strength came from its accrual and skillful management of overseas possessions, in keeping with the colonialist climate of the times; the empire ultimately covered a quarter of the world's surface. Colonies were used mainly for their resources to the benefit of the colonizer, somewhat constraining their potential development. Even China, which notionally escaped colonization, was invaded and carved up first by Western powers and then by Japan.
The United States, by contrast, had escaped from colony status only 170 years before and, though Washington flirted with colonialism with its possessions in the Philippines, it was a U.S. president, Woodrow Wilson, who lit the flash paper that ultimately ended imperialism. Thus, the U.S. style of world leadership was much closer to leading by normative pressure than forceful imposition of will (though admittedly it was not averse to the use of manipulation and coups to promote its interests). It promoted self-determination and democracy wherever possible, encouraged free trade by guaranteeing the sea-lanes with its dominant navy and challenged the Soviet Union in its attempts to dominate Eurasia. The price the United States charged for this service was control. It poured money into Western Europe and Japan and developed these powers as useful lieutenants to its global policeman role; together these industrial nations have shaped today's world, partly through the institutions that were created at Bretton Woods, such as the IMF.
As these institutions were being developed, the United States was also cornering the international currency market. Another part of the new order was the re-creation of a gold standard based on the dollar, which made it the global reserve currency by definition. This role gives its holder great power, since external demand for its currency allows it to print itself out of trouble in ways that others cannot. Though the United States ultimately followed that course it initially did not want to devalue its currency by printing more dollars, and as a result there was a global shortage of available dollars for foreign central banks to hold. The SDR was created in 1969 as a new kind of global reserve currency, a sort of "paper gold" that could be used to settle accounts between central banks in place of the dollar. (SDR notes could be held by official institutions and exchanged upon request for a set amount of gold; the currency was meant to facilitate lending between debtor and creditor countries at the state level).
But the SDR never really took off, partly because a new floating currencies system emerged after 1971, when the now devalued dollar made the gold standard untenable. This new system undermined the SDR's dollar-replacement role because with no gold standard to keep to, the United States was free to print more dollars, alleviating the previous shortage. The SDR itself became exchangeable not for gold but for a set quantity of a selected group of recognized currencies. This is the elite group the yuan just joined. As the floating currencies system emerged, and the dollar was freed from its golden shackles, the international central banks stuck with it, leaving the SDR somewhat in the shadows. In its history, the SDR, which is issued by the IMF itself, has never made up more than 6 percent of overall international reserves.
Dealing With New Realities
But the domination of the global economic system by the United States and its wealthy friends always had an expiration date, because of the rule of thumb that, when given the opportunity, lower-income countries can grow much faster than wealthy ones. Lower-income countries have the wealthy ones as guides. A wealthy country must develop new technologies and techniques to help it grow - an often lengthy process. Lower-income countries, however, can devote their energies to applying the tried and tested methods and technologies that made the rich countries rich. Of course, one must also be aware of the law of small numbers, in which the growth effect is exaggerated by the fact that a percentage increase in a small number is in reality a smaller rise than the equivalent growth in a larger economy. This means that sometimes high growth figures are not as impressive as they first appear. Nevertheless, the first rule has outweighed the second rule in this case, and many lower-income countries have made strong gains on the wealthier ones. In previous centuries, lower income countries were liable to be taken over by wealthier colonizers, but even if they escaped that fate, there was still no guarantee that they would be able to acquire the expertise and capital needed to develop themselves (Japan is a notable exception).
