Also known simply as a
reserve currency
, or less frequently, an “anchor currency,” the world reserve currency is more like a vehicle or container - like a 401(k) or RRSP - which can hold a certain currency inside. In other words,
there is no essential or necessary world reserve currency
. It could be any currency - even one that does not exist yet. Right now the reserve currency happens to be the US dollar. It has been since the
Bretton Woods agreements
of July 1944. This was when the U.S. was a creditor nation and the fastest-growing world economy.
Reserve currencies have been in effect for centuries. And in fact, with much of the new recent hoopla about supplanting the US dollar as the reserve currency, it’s worth noting that this may be an escalating trend, but similar calls were also made in the 1970’s over similar worries about the world financing US deficits.
Certain amounts of the world reserve currency are held in foreign exchange reserves by governments (and sovereign wealth funds) and institutions (like the IMF) around the world. But foreign exchange reserves around the world do not *only* hold the world reserve currency: while the US dollar is always a majority of their holdings, the Euro is a close second (about 25% of holdings), and other major currencies (Swiss Francs, Yen, pounds, Canadian dollars) are also held. Thus, strictly speaking, these are also reserve currencies, with an important caveat:
The world reserve currency also acts as the international pricing currency for oil, gold, and other products traded on world markets. You can’t trade oil in Euros and countries can’t trade gold in Yen. This gives an advantage to the US dollar because other countries need to transact to exchange their own money into dollars first. It has even been argued that this serves to artificially inflate the US dollar insofar as it becomes the only reason countries need to hold it.
Recently, China, Russia, India and France have expressed more concern over needing to hold their wealth in dollars . Why? Because of the massive debts of the US government. The US is no longer a creditor nation. It now borrows more money from the rest of the world than ever, and more than any other country does currently as well. These countries are concerned about their investments dropping. When you price the value of the dollar against the amount of gold (or oil) it buys, you see a tremendous decline in purchasing power.
Alternatives have been proposed, from using the Euro to using SDRs (special drawing rights) to a completely new “ united world reserve currency .” Time will tell what happens. As of July 2009, leaders seem to want to focus on improving the world economy rather than dealing with this piece of its structure. We will see how wise is that decision and what kind of developments it undergoes.
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{ 3 comments… read them below or add one }
I think China is positioning itself. It’s been arranging currency swaps with other developing nations, and diversifying investments. China takes the long view, though. Any change is likely to come slowly, and not really take effect for at least two decades.
I find this whole currency thing facinating and I love how your breaking it down into bite sized peices in different posts. Your making it much easier to understand!
Before the renminbi can supplant the US as the world’s reserve currency, there are going to have to be some significant policy changes over in COMMUNIST China:
1. The financial reforms currently underway have to be continued
2. Restrictions will have to be eased on money entering and leaving COMMUNIST China
3. The COMMUNISTS will have to relinquish their dictatorial stranglehold on the country
Until all three of those changes occur, the renminbi will not supplant the US dollar. If and when they do occur, however, I suspect the change over from the US dollar to the renminbi as the world’s reserve currency will be rapid.
By the way, am I the only one who can’t say renminbi three times in quick succession without needing a chopstick to untie the knot in my tongue? lol
My $0.02 (after taxes)
Len
Len Penzo dot Com