Is the World Ready for a New Reserve Currency? Meet the Mondo

As the G-20 meets to discuss the world's economic problems -- with many of its members unhappy about the Federal Reserve's efforts to stimulate the U.S. economy by boosting its money supply -- ideas are floating around about new monetary systems. For a host of reasons, leaders of other countries would love to free their economies from the stranglehold of the U.S. dollar's influence.

World Bank President Robert Zoellick recently called for the world to index its currencies to gold. In his proposed system, major currencies in the world such as the dollar, the euro, the yen, the pound and the yuan would move towards adopting a modified gold standard. The precious metal would be used as a reference point that would guide currency movements based on market expectations of inflation, deflation and future currency values.

That would be great for those who are holding gold now, because it would boost demand for gold -- thus causing it to rise in price even more. But since there isn't nearly enough physical gold to back all the currencies around the world, returning to the gold standard would cause a massive reduction in the money supply, which would lead to rapid economic contraction.

Zoellick, under a barrage of criticism for the proposal, backpedaled on Wednesday, suggesting he had been misunderstood. "I'm not advocating a return to the 19th century, when money supply was linked to gold," said Zoellick. Good job, Bob.

Introducing the Mondo

The gold standard aside, I'd like to see the world adopt a new reserve currency to supplant the dollar: Call it the Mondo (from the Italian word for world). This new currency would be based on each country's contribution to global GDP. Thus, the more important a country's economy, the bigger that country's influence on the Mondo's value.

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In concept, it's fairly simple. The world's GDP is $61 trillion, according to the World Bank, and the Mondo would be based on a weighted basket of securities from each country in proportion to their share of global GDP. The beauty of the Mondo is that it would allow the world's economy to turn on the basis of changes in the policies of individual national economies in proportion to their real contribution in the global marketplace.

The Mondo's value would fluctuate daily based on changes in the levels of its component currencies -- just like a stock index does. So the U.S., which has 23% of the world's economy ($13.9 trillion in so-called purchasing power parity GDP -- a common measure of what a currency can buy around the world) would see the dollar contribute 23% of its weight to the value of the Mondo. China's yuan would contribute 11% to the weight of the Mondo, since its PPP GDP is $7 trillion, or 11% of global GDP.

Shifting to the Mondo would be great for consumers. Today, commodities like oil are traded in dollars, so when the value of the dollar drops, the price of oil goes up. That's why gasoline prices have been surging higher recently in the face of the Fed's decision to boost the U.S. money supply by $600 billion.

But if oil was traded in Mondos, the Fed's decision would have a much smaller impact on its price, because the value of the Mondo also would heavily reflect the policies of other major world economies China and Japan. And since those countries have not just announced massive stimulus programs, the Mondo would not have dropped as much as the dollar has.

Adoption of the Mondo would help also ease U.S. tensions with China, which holds much of its trillions in reserves in U.S. government securities. If China held those reserves in Mondos, then the negative effect of the weakening dollar on Chinese reserves would be reduced dramatically.

It Took Nixon to Shift the Reserve Currency Standard

It's not hard to imagine the uproar that would ensue if the major economic powers made a serious effort to create the Mondo, or something similar, and bring it into use. Each country would calculate the costs and benefits of swapping out of the dollar as a reserve currency, and countries that found themselves worse off in the short-term would balk at implementing it.

But the world was able to adapt back on Aug. 15, 1971, when President Richard Nixon took the U.S. off the gold standard to "defend the U.S. against currency speculators." The world quickly followed the America's lead.

If using the dollar as a reserve currency becomes too painful, perhaps the global pressure to adopt the Mondo will get strong enough to overcome these objections.