Reserve currency
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A reserve currency, or anchor currency, is a currency that is held in significant quantities by many governments and institutions as part of their foreign exchange reserves. It also tends to be the international pricing currency for products traded on a global market, and commodities such as oil, gold, etc.
This permits the issuing country to purchase the commodities at a marginally lower rate than other nations, which must exchange their currencies with each purchase and pay a transaction cost. For major currencies, this transaction cost is negligible with respect to the price of the commodity. It also permits the government issuing the currency to borrow money at a better rate, as there will always be a larger market for that currency than others.
History
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As emphasised by the economist Avinash Persaud reserve currencies come and go. "International currencies in the past have included the Chinese Liang and Greek drachma, coined in the fifth century B.C., the silver punch-marked coins of fourth century India, the Roman denari, the Byzantine solidus and Islamic Dinar of the middle-ages, the Venetian ducato of the Renaissance, the seventeenth century Dutch guilder and of course, more recently, sterling and the dollar.”[1]
Before 1944, the world reference currency was the Pound Sterling. The transition between Pound Sterling and US Dollar in reserves and its impact for central banks was described recently.[2]
After World War II, the international financial system was governed by a formal agreement, the Bretton Woods System. Under this system the US dollar was placed deliberately as the anchor of the system, with the US government guaranteeing other central banks that they could sell their US dollar reserves at a fixed rate for gold. European countries and Japan deliberately devalued their currencies against the dollar in order to boost exports and development.[3]
In the late 1960s and early 70s the system suffered setbacks due to problems pointed out by the Triffin dilemma, a general problem with any fiat currency under a fixed exchange regimen, as the dollar was in the Bretton Woods system.[citation needed]
Global currency reserves
A 2011 study about the current dominant reserve currency in central banks shows that dollar may not be the obvious dominant currency, because of the major part of Unallocated Reserves increasingly reported by central banks since 2001 .[4] Thus the following table is only a limited view of the question about the currency reserves :
| 2023 | 2022 | 2021 | 2020 | 2019 | 2018 | 2017 | 2016 | 2015 | 2014 | 2013 | 2012 | 2011 | 2010 | 2009 | 2008 | 2007 | 2006 | 2005 | 2004 | 2003 | 2002 | 2001 | 2000 | 1995 | 1990 | 1985 | 1980 | 1975 | 1970 | 1965 | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| US dollar | 58.41% | 58.52% | 58.80% | 58.92% | 60.75% | 61.76% | 62.73% | 65.36% | 65.73% | 65.14% | 61.24% | 61.47% | 62.59% | 62.14% | 62.05% | 63.77% | 63.87% | 65.04% | 66.51% | 65.51% | 65.45% | 66.50% | 71.51% | 71.13% | 58.96% | 47.14% | 56.66% | 57.88% | 84.61% | 84.85% | 72.93% |
| Euro (until 1999 - ECU) | 19.98% | 20.40% | 20.59% | 21.29% | 20.59% | 20.67% | 20.17% | 19.14% | 19.14% | 21.20% | 24.20% | 24.05% | 24.40% | 25.71% | 27.66% | 26.21% | 26.14% | 24.99% | 23.89% | 24.68% | 25.03% | 23.65% | 19.18% | 18.29% | 8.53% | 11.64% | 14.00% | 17.46% | |||
| Japanese yen | 5.70% | 5.51% | 5.52% | 6.03% | 5.87% | 5.19% | 4.90% | 3.95% | 3.75% | 3.54% | 3.82% | 4.09% | 3.61% | 3.66% | 2.90% | 3.47% | 3.18% | 3.46% | 3.96% | 4.28% | 4.42% | 4.94% | 5.04% | 6.06% | 6.77% | 9.40% | 8.69% | 3.93% | 0.61% | ||
| Pound sterling | 4.84% | 4.92% | 4.81% | 4.73% | 4.64% | 4.43% | 4.54% | 4.35% | 4.71% | 3.70% | 3.98% | 4.04% | 3.83% | 3.94% | 4.25% | 4.22% | 4.82% | 4.52% | 3.75% | 3.49% | 2.86% | 2.92% | 2.70% | 2.75% | 2.11% | 2.39% | 2.03% | 2.40% | 3.42% | 11.36% | 25.76% |
| Canadian dollar | 2.58% | 2.38% | 2.38% | 2.08% | 1.86% | 1.84% | 2.03% | 1.94% | 1.77% | 1.75% | 1.83% | 1.42% | |||||||||||||||||||
| Chinese renminbi | 2.29% | 2.61% | 2.80% | 2.29% | 1.94% | 1.89% | 1.23% | 1.08% | |||||||||||||||||||||||
| Australian dollar | 2.11% | 1.97% | 1.84% | 1.83% | 1.70% | 1.63% | 1.80% | 1.69% | 1.77% | 1.59% | 1.82% | 1.46% | |||||||||||||||||||
| Swiss franc | 0.23% | 0.23% | 0.17% | 0.17% | 0.15% | 0.14% | 0.18% | 0.16% | 0.27% | 0.24% | 0.27% | 0.21% | 0.08% | 0.13% | 0.12% | 0.14% | 0.16% | 0.17% | 0.15% | 0.17% | 0.23% | 0.41% | 0.25% | 0.27% | 0.33% | 0.84% | 1.40% | 2.25% | 1.34% | 0.61% | |
| Deutsche Mark | 15.75% | 19.83% | 13.74% | 12.92% | 6.62% | 1.94% | 0.17% | ||||||||||||||||||||||||
| French franc | 2.35% | 2.71% | 0.58% | 0.97% | 1.16% | 0.73% | 1.11% | ||||||||||||||||||||||||
| Dutch guilder | 0.32% | 1.15% | 0.78% | 0.89% | 0.66% | 0.08% | |||||||||||||||||||||||||
| Other currencies | 3.87% | 3.48% | 3.09% | 2.65% | 2.51% | 2.45% | 2.43% | 2.33% | 2.86% | 2.83% | 2.84% | 3.26% | 5.49% | 4.43% | 3.04% | 2.20% | 1.83% | 1.81% | 1.74% | 1.87% | 2.01% | 1.58% | 1.31% | 1.49% | 4.87% | 4.89% | 2.13% | 1.29% | 1.58% | 0.43% | 0.03% |
| Source: World Currency Composition of Official Foreign Exchange Reserves International Monetary Fund | |||||||||||||||||||||||||||||||
Theory
Economists debate whether a single reserve currency will always dominate the global economy.[5] Many have recently argued that one currency will almost always dominate due to network externalities, especially in the field of invoicing trade and denominating foreign debt securities, meaning that there are strong incentives to conform to the choice that dominates the marketplace. The argument is that, in the absence of sufficiently large shocks, a currency that dominates the marketplace will not lose much ground to challengers.
However, some economists, such as Barry Eichengreen argue that this is not as true when it comes to the denomination of official reserves because the network externalities are not strong. As long as the currency's market is sufficiently liquid, the benefits of reserve diversification are strong, as it insures against large capital losses. The implication is that the world may well soon begin to move away from a financial system dominated uniquely by the United States dollar. In the first half of the 20th century multiple currencies did share the status as primary reserve currencies. Although the British Sterling was the largest currency, both the French franc and the German mark shared large portions of the market until the First World War, after which the mark was replaced by the dollar. Since the Second World War, the dollar has dominated official reserves, but this is likely a reflection of the unusual domination of the American economy during this period, as well as official discouragement of reserve status from the potential rivals, Germany and Japan.
The top reserve currency is generally selected by the banking community for the strength and stability of the economy in which it is used. Thus, as a currency becomes less stable, or its economy becomes less dominant, bankers may over time abandon it for a currency issued by a larger or more stable economy. This can take a relatively long time, as recognition is important in determining a reserve currency. For example, it took many years after the United States overtook the United Kingdom as the world's largest economy before the dollar overtook Sterling as the dominant global reserve currency.[citation needed]
The G8 also frequently issues public statements as to exchange rates. In the past due to the Plaza Accord, its predecessor bodies could directly manipulate rates to reverse large trade deficits.
Major reserve currencies
United States dollar
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The United States dollar is the most widely held reserve currency in the world today. Throughout the last decade, an average of two thirds of the total allocated foreign exchange reserves of countries have been in U.S. dollars. For this reason, the U.S. dollar is said to have "reserve-currency status," making it somewhat easier for the United States to run higher trade deficits with greatly postponed economic impact or even postponing a currency crisis. Central bank reserves held in dollar-denominated debt, however, are small compared to private holdings of such debt. In the event that non-United States holders of dollar-denominated assets decided to shift holdings to assets denominated in other currencies, there could be serious consequences for the U.S. economy. Changes of this kind are rare, and typically change takes place gradually over time; the markets involved adjust accordingly.
However, the dollar remains the favorite reserve currency because it has stability along with assets such as United States Treasury security that have both scale and liquidity.[6]
Euro
The euro is currently the second most commonly held reserve currency, comprising approximately a quarter of allocated holdings. After World War II and the rebuilding of the German economy, the German Deutsche Mark gained the status of the second most important reserve currency after the US dollar. When the euro was launched on January 1, 1999, replacing the Mark, French Franc and ten other European currencies, it inherited the status of a major reserve currency from the Mark. Since then, its contribution to official reserves has risen continually as banks seek to diversify their reserves and trade in the eurozone continues to expand.[7]
Former Federal Reserve Chairman Alan Greenspan said in September 2007 that the euro could replace the U.S. dollar as the world's primary reserve currency. It is "absolutely conceivable that the euro will replace the dollar as reserve currency, or will be traded as an equally important reserve currency."[8] Econometric analysis by Jeffery Frankel and Menzie Chinn in 2006 suggests the euro may replace the U.S. dollar as the major reserve currency by 2020 if: (1) the remaining EU members, including the UK, adopt the euro by 2020 or (2) the recent depreciation trend of the dollar persists into the future.[9][10] In recent years, the euro's increase in the share of the worldwide currency reserve basket has continued to increase - albeit at a slower rate than prior to the beginning of the worldwide credit crunch related recession and sovereign debt crisis [11]
Other reserve currencies
Pound sterling
The United Kingdom's pound sterling was the primary reserve currency of much of the world in the 19th century.[citation needed] U.S. and German economic dominance from the second half of the 19th century onward, the emergence of the USA as an economic superpower (and, importantly, the establishment of the U.S. Federal Reserve System in 1913) as well as economic weakness in the UK at various intervals during the second half of the 20th century resulted in Sterling losing its status as the world's most reserved currency.[citation needed]
Since mid-2006 it is the third most widely held reserve currency, having seen a resurgence in popularity in recent years, but growing from about 2.5% to just below 5% of all currency reserves.[12] Analysts say this resurgence is caused by carry-trade investors considering the pound as a stable high-yield proxy to the euro, as well as the prominence of London in world financial affairs.[13]
Japanese yen
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Japan's yen is part of the IMF's Special Drawing Rights Valuation. The SDR currency value is determined daily by the IMF, based on the exchange rates of the currencies making up the basket, as quoted at noon at the London market. The valuation basket is reviewed and adjusted every five years.
The SDR Values and yen conversion for government procurement are used by Japan's JETRO for Japan's official procurement in international trade.
Canadian dollar
A number of central banks (and commercial banks) keep Canadian dollars as a reserve currency. The Canadian dollar is considered to be a benchmark currency.[14]
In the economy of the Americas the Canadian dollar plays a similar role to that which the Australian Dollar (AUD) does in the Asia-Pacific region. The Canadian dollar (as a regional reserve currency for banking) has been an important part of the British, French and Dutch Caribbean state's economies and finance systems since the 1950s. The Canadian dollar is held by many central banks in Central America and South America as well. The holding of the Canadian dollar in Latin America is done so because of each nation's nationally important issues of remittances and international trade.
Canadian economists primarily define and value the Canadian dollar in terms of the United States dollar, and thus by observing how the Canadian dollar floats in terms of the U.S. dollar, foreign-exchange economists can indirectly observe internal behaviours and patterns in the U.S. economy that could not be seen by direct observation (Canada’s primary foreign-trade relationship is with the United States). Also, considered a petrodollar, the Canadian dollar has only fully evolved into a global reserve currency since the 1970s when it was floated against all other world currencies. Some economists have attributed the rise of importance of the Canadian dollar to the long term effects of the Nixon Shock that effectively ended the Bretton Woods system of global finance. [citation needed]
The Canadian dollar is used as a reserve currency around the world and is currently ranked 6th in value held as reserves.[citation needed]
Swiss franc
The Swiss franc is often considered a reserve currency, because of the perceived stability of the currency and the Swiss banking system.[citation needed] However, the share of all foreign exchange reserves held in Swiss francs has historically been well below 0.5%. The daily trading market turnover of the franc however, ranked fifth, or about 3.4%, among all currencies in a 2007 survey by the Bank for International Settlements.[15]
Call for new major reserve currency
Other nations, such as Russia and the People's Republic of China, central banks, and economic analysts and groups, such as the Gulf Cooperation Council, have expressed a desire to see an independent new currency replace the dollar as the reserve currency. China has proposed using the Special Drawing Rights, calculated daily from a basket of U.S. dollar, euro, Japanese yen and British pound, used by the International Monetary Fund for international payments.[16]
On 3 September 2009, UNCTAD issued a report calling for a new reserve currency based on the SDR, managed by a new global reserve bank.[17]
On 10 July 2009, Russian President Medvedev proposed a new 'world currency' at the G8 meeting in London as an alternative reserve currency to replace the dollar. [18]
According to economist Michael Hudson China has said, "we don't want to make any more foreign exchange reserve of any paper currency, because all the paper currencies are government debt currencies." China, Russia, India, Turkey, Brazil, Venezuela and oil-producing countries have recently agreed "to transact all of their mutual trade and investment in their own currencies" effectively minimizing the need, at least in the short term, for a global reserve currency. [19] And yet oil is still priced in dollars, which has brought complaints about OPEC's policies of managing oil quotas to maintain dollar price stability.[20]
Chinese yuan
The Chinese yuan or renminbi (RMB) cannot be used as a reserve currency as long as the Chinese government maintains capital controls on the conversion of its currency.[21] The currency would not be attractive to central banks for holding unless China developed a strong open bond market.[22]
Chinese President Hu Jintao has said that it would be a long process before the yuan was accepted as a global currency.[23]
See also
- Exorbitant privilege
- Floating currency
- Foreign exchange reserves
- Hard currency
- Triffin dilemma
- World currency
- Special Drawing Rights
References
- ^ Helmut Reisen. "Shifting wealth: Is the US dollar Empire falling?". voxeu.org. Retrieved 2011-07-03.
- ^ "The Retirement of Sterling as a Reserve Currency after 1945: Lessons for the US Dollar ?", Catherine R. Schenk, Canadian Network for Economic History conference, 10/2009
- ^ http://www.treasury.gov/resource-center/international/exchange-rate-policies/Documents/Appendix%201%20Final%20October%2015%202009.pdf
- ^ http://conscience-sociale.blogspot.com/2011/06/how-to-replace-world-trade-reference.html
- ^ Eichengreen, Barry (2005). "Sterling's Past, Dollar's Future: Historical Perspectives on Reserve Currency Competition" (PDF). National Bureau of Economic Research (NBER).
{{cite web}}: Unknown parameter|month=ignored (help) - ^ "In a world of ugly currencies, the dollar is sitting pretty". Economist.com. 2010-05-06. Retrieved 2010-08-22.
- ^ Lim, Ewe-Ghee (2006). "The Euro's Challenge to the Dollar: Different Views from Economists and Evidence from COFER (Currency Composition of Foreign Exchange Reserves) and Other Data" (PDF). IMF.
{{cite web}}: Unknown parameter|month=ignored (help) - ^ "Reuters". Euro could replace dollar as top currency — Greenspan. 2007-09-17. Retrieved September 17, 2007.
- ^ Menzie, Chinn (2006). "Will the Euro Eventually Surpass The Dollar As Leading International Reserve Currency?" (PDF). NBER. Retrieved 2007-10-11.
{{cite journal}}: Unknown parameter|coauthors=ignored (|author=suggested) (help); Unknown parameter|month=ignored (help) - ^ "Aristovnik, Aleksander & Čeč, Tanja, 2010. "Compositional Analysis Of Foreign Currency Reserves In The 1999-2007 Period. The Euro Vs. The Dollar As Leading Reserve Currency," Journal for Economic Forecasting, Vol. 13(1), pages 165-181" (PDF). Institute for Economic Forecasting. 2010-07-19. Retrieved 2010-07-05.
- ^ "Currency Composition of Official Foreign Exchange Reserves (COFER) – Updated COFER tables include first quarter 2009 data. June 30, 2009" (PDF). Retrieved 2009-07-08.
- ^ Blackden, Richard (2007-01-23). "Sterling surges to 14-year high". The Daily Telegraph. London. Retrieved 2007-01-24.
- ^ "Currency Strategists: Morgan Says Pound Is Euro Proxy". xak.com. Bloomberg. 2006-02-08.
- ^ Benchmark currencies of the world
- ^ "Triennial Central Bank Survey, Foreign exchange and derivatives market activity in 2007" (PDF). Bank for International Settlements. December 2007.
- ^ "China backs talks on dollar as reserve -Russian source, Reuters, 19 March 2, 2009". Reuters.com. 2009-03-19. Retrieved 2010-08-22.
- ^ "UNCTAD Trade and Development Report 2009". Unctad.org. 2002-10-06. Retrieved 2010-08-22.
- ^ "Medvedev Shows Off Sample Coin of New 'World Currency' at G-8". Reuters.com. 2009-07-10. Retrieved 2010-10-14.
- ^ "World Tired of Paying Bill for US Military". therealnews.com. 2010-12-27.
- ^ Burleigh, Marc. "OPEC leaves oil quotas unchanged, seeing economic 'risks'." AFP, 11 December 2010.
- ^ "Yuan starts on long slog to reserve currency status". Reuters.com. 2009-07-06. Retrieved 2010-08-22.
- ^ Steve LeVine (2009-05-26). "China's Yuan: The Next Reserve Currency?". Business Week.
- ^ "China's Hu Jintao: Currency system is 'product of past'." BBC, 16 January 2011.