THE current global monetary system is heavily dominated by one single currency, the US dollar, that is not subject to the constraints of any international arrangements. This dominance allows the US to attract large amounts of liquidity in good times, and to dilute its debts through aggressive monetary policy in bad times.

Not many people are happy with this system, but the road to an alternative is unclear. The call for a global reserve currency will be proven only rhetoric in the end. A reserve currency, as many have conceived, cannot circulate; nor can it be used as an investment vehicle. In the end, a “real” currency is needed to preserve the value of savings stored in the form of the reserve currency.

Unless a global central bank were created, there would be no hope for a global reserve currency to replace the US dollar. However, creating a global central bank may not be a good solution even if it is possible. The recent crisis facing the euro rings the bell for any optimism.

In the end, a solution to replace the so-called “Bretton Woods 2” that may naturally emerge from the current world order is the competition, and hopefully cooperation, among several major currencies. Besides the dollar, the euro has played a significant role in global trade and finance. The Japanese yen and the British pound are also around although they have not reached significant primacy. The Chinese yuan may take some share if the Chinese authorities open up the country’s capital account. Currencies in other emerging markets also have hope. The competition among several major currencies will help preventing liquidity from concentrating in a few countries and will constrain irresponsible behaviour in the management of individual currencies.

On top of that, some binding multilateral mechanism is needed to coordinate the exchange rates among the major currencies, especially in bad times. The G20 is a potential venue for such a mechanism. However, the current floating system is inadequate for this mechanism to function; it gives a “legitimate” reason for the US to dump its domestic problems to the rest of the world by devaluing the dollar.

A better alternative is to adopt a mixed system in which the major currencies form some sort of an alliance to coordinate their exchange rates and other currencies choose either to float against the major currencies or to peg to them. The coordination needs not to require completely fixed exchange rates among the major currencies, but needs to be sufficiently real to place constraints on them.

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