A New Global Reserve Currency

Before the G20 meetings, representatives from Russia, China and Kazakhstan argued that the dollar needed to be replaced by a new reserve currency.  Christopher Beam, writing for Slate in "World Wad," does a good job of explaining some issues involved with a new currency, including where it might originate, and how it might trade.  Beam begins by explaining the role of a reserve currency.

It [a reserve currency] serves as a standard unit for international payments, and it protects your own currency against shock. If demand for yen drops, for example, Japan can use their extra U.S. dollars to buy up the unwanted yen, thereby propping up its value. At the same time, though, the country whose currency is held in reserve—in this case, the United States—is more vulnerable to shock, since so much of its currency is in foreign accounts and therefore inaccessible to the United States. Transitioning to a hybrid reserve currency would therefore protect both weaker economies, which are usually vulnerable to another single country's ups and downs, and stronger ones, which would have more ability to control and stabilize their own currencies.

Beam notes that nobody is forced to use the dollar as a reserve currency.  It was their choice.

Countries aren't required to keep their reserves in dollars—they do it because they want to. (The dollar's "primary reserve currency" status is more de facto than official.) But if China dumped its reserve of dollars it would jeopardize its relationship with the United States, and other countries wouldn't necessarily do the same. Any systematic overhaul would have to be done cooperatively and a switch to the SDR requires approval from the IMF, which is controlled by the United States.

As an additional observation, China has other assets denominated in dollars, U.S. treasuries for example.  If they dumped dollars, they would lower its value and the value of dollar denominated assets. 

The new reserve currency would probably be a market basket of world currencies. 

Medvedev, the Chinese economic minister, and other would-be reformers want to create an accounting unit based on a "basket" of other currencies—a sort of hybrid. Instead of countries holding billions of U.S. dollars in their reserves—which makes them vulnerable if the dollar drops suddenly—they would hold a new unit, composed of, say, the dollar, the pound, and the Euro. The value of each component currency might fluctuate, but if one drops, the others can serve as "hedges."

The most prominent example of such a basket is the Special Drawing Rights—or SDR—overseen by the International Monetary Fund. The value of the SDR is composed of 44 percent U.S. dollar, 34 percent euro, 11 percent yen, and 11 percent British pound. So if the U.S. dollar loses half its value, the SDR declines by 22 percent. Today, one SDR is worth 1.49 U.S. dollars. You can't withdraw SDRs at the ATM, but you can use them for accounting transactions. Some countries, such as Syria, peg their currencies to the SDR. (This role earned the SDR the nickname "paper gold.") Zhou proposes making the SDR the new reserve unit but suggests expanding it to include all other major currencies as well.

Proponents of a new reserve currency include more than countries with a possible axe to grind.  It includes heavy-weight economists like Nobel Prize winners Edmund Phelps and Robert Mundell, the intellectual father of the Euro ("Kazakhstan, Eurasia take heart from G-20 measures to control global meltdown," Thaindian News, April 4, 2009).  Mundell believes that the dollar should represent about 40% of the market basket of currencies compared to the current 45% ("Mundell: China's economic growth expected to reach between 7 and 8 percent," People's Daily Online, April 9, 2009).