A friend writes,* “What the end of hegemony looks like…”

In another indication that China is growing increasingly concerned about holding huge dollar reserves, the head of its central bank has called for the eventual creation of a new international currency reserve to replace the dollar.

In a paper released Monday, Zhou Xiaochuan, governor of the People’s Bank of China, said a new currency reserve system controlled by the International Monetary Fund could prove more stable and economically viable.

A new system is necessary, he said, because the global economic crisis has revealed the “inherent vulnerabilities and systemic risks in the existing international monetary system.”

On the one hand, true. China’s over $1 trillion in dollar-denominated reserves aren’t as safe as they once were, and a devaluation of that asset through inflation would not be good for China. But, where else are they going to go?

While few analysts believe that the dollar will be replaced as the world’s dominant foreign exchange reserve anytime soon, the proposal suggests that China is preparing to assume a more influential role in the world. Russia recently made a similar proposal.

Lets look at this more closely. The Dollar has its privileged position in the world economy because a) many economists believe that the world economy needs some sort of stable reserve currency, b) the US is willing and can afford to maintain such a strong currency, and c) the rest of the world has left this arrangement unchallenged and benefits from it. Much of this is classic Kindleberger–the world economy needs a stabilizer, one stabilizer, to stabilize the global economy as market, currency, and lender of last resort. The US is that stabilizer.

The third of those reasons–acceptance by other world powers–is now under some degree of threat as China starts to fret about its dollar position. However, absent another actor willing and able to play the role of stabilizer, everyone–China included–risks putting themselves in a significantly worse position should the dollar lose its pride of place in the international economic system.

China suggests that the IMF’s SDR form a new reserve currency. This indicates they really aren’t all that serious about actually doing anything to dislodge the dollar. For one, to have a currency able to act as a reserve currency requires backing of a stable, authoritative, empowered entity that can manipulate fiscal and monetary policy as needed to protect the value of its currency. We call this a sovereign state. To give the IMF such rights would make the IMF a de-facto global economic sovereign. China has no demonstrated desire to create supra-national authority, not at the UN, nor the IMF. Moreover, there is a significant and real cost to maintaining a strong reserve currency. The strength of the dollar makes the US a great destination for products–we can afford to buy others’ cheap stuff. A significantly de-valued dollar (coupled with an increased value of other currencies like the Yuan or Yen or Won) would be a disaster to economies that rely on exports. China would need to show that it is willing and able to take on a stabilizing role in the global economy, which just doesn’t seem in the cards as of yet.

Perhaps, though, this might be read as an attempt to gain leverage:

The timing of the Chinese announcement, analysts said, could also be aimed at giving Beijing more leverage to negotiate with the United States and other nations in London on trade and on proposals about how to stabilize the global economy.

All that said, it would be foolish for US policy planners to simply ignore China’s (and others) growing dissatisfaction with the Bretton Woods legacy system that now constitutes the global economy. The fundamental bargains that made such a hegemonic system possible (cf Ikenberry) have become frayed, and while neither China nor the EU (nor India, for that matter) are poised to overthrow US hegemony in the short term, they can clearly erode US hegemony by driving up the cost of acting as a stabilizer. In the medium term, this imposes a cost on everyone, as the global economy (and security order) falters without a clear stabilizer, but from a realist perspective, the relative gains (or in this case declines) could benefit the challengers to US hegemony–at least that’s what they are betting on.

*as in, a friend of mine forwarded me a link to that article with the caption. I have never met David Barboza, the author of the NYT article.