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Could the Dollar be Replaced as the World Reserve Currency? DinarDailyUpdates?bg=330099&fg=FFFFFF&anim=1

Could the Dollar be Replaced as the World Reserve Currency?

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Could the Dollar be Replaced as the World Reserve Currency? Empty Could the Dollar be Replaced as the World Reserve Currency?

Post by claud39 Tue Aug 11, 2020 4:16 pm

[size=31]Could the Dollar be Replaced as the World Reserve Currency?[/size]

By Frances Coppola

The possibility of the dollar being replaced as the world reserve currency has been a topic of discussion in economic circles for nearly two decades. But what could replace the dollar, and how might this affect the dollar’s exchange rate, the U.S. economy—and import-export businesses looking to manage their exchange rate risk?

What Does ‘World Reserve Currency’ Mean?


“World reserve currency” means a currency that many central banks hold as part of their FX reserves. In theory, any currency could be a world reserve currency. But in practice, central bank FX reserves are dominated by a few currencies. These currencies are typically issued by well-managed central banks on behalf of governments which have a history of meeting their obligations. As a result, they tend to have stable exchange rates and low inflation. This makes them attractive both for international trade and as long-term savings vehicles.


The International Monetary Fund (IMF) recognizes eight world reserve currencies: U.S. dollar, euro, Chinese renminbi (yuan), Japanese yen, British pound, Australian dollar, Canadian dollar and Swiss franc. Of these, USD is by far the most widely used in global FX reserves. Nearly 60 percent of the world’s FX reserves are denominated in dollars. In the second quarter of 2019, the total dollar value of global FX reserves stood at $11.7 trillion, of which $6.8 trillion were in dollars or dollar-denominated assets.1 For this reason, the dollar is often referred to simply as the world reserve currency.


How Does World Reserve Currency Status Affect Exchange Rates?


The dollar’s dominance in FX reserves is thought to confer an “exorbitant privilege” on the U.S., enabling it to borrow large amounts at low interest rates without fear of a “sudden stop.” However, some economists point out that this privilege is not without cost, since it may keep the dollar’s exchange rate too high for balanced trade, hampering U.S. exporters.2 The U.S.’s role as safe asset provider to the world also means that in a financial crisis, it could find itself responsible for bailing out the global financial system, as happened in 2008.3


The second most favored world reserve currency is the euro, which in the second quarter of 2019 accounted for $2.2 trillion of total global FX reserves, or just under 20 percent. Of the remaining 20 percent, the yen and sterling between them account for approximately half.4


Since central bank FX reserves are used to settle international payments, the dominance of the dollar in international trade explains the dollar’s prevalence in global FX reserves. However, trade is not the only reason that central banks keep FX reserves. They also maintain reserves as a buffer against sudden exchange rate swings.


Is the World Moving Toward ‘Multi-Polar’ Reserve Currencies?


Although the dollar is globally dominant, countries also tend to hold the currencies of the dominant trading nation in their vicinity. Thus, European countries outside the Eurozone tend to hold the euro, and Asian countries hold the yen and, increasingly, the renminbi. Some economists argue that this tendency could develop into a full-fledged “multi-polar” system in which the dollar would be the principal reserve currency for the Americas, the euro would be the principal reserve currency for Europe and Africa, and the renminbi for Asia and Australasia.5


Should a multi-polar reserve currency system emerge, then global demand for both dollars and dollar-denominated safe assets might subside, while demand for euros and renminbi, and their associated safe assets, might increase. This could mean a lower dollar exchange rate, particularly in relation to the euro and the renminbi, and higher interest rates on dollar-denominated securities, notably U.S. government debt.


Obstacles to a Multi-Polar Reserve System


However, there are currently significant obstacles to the adoption of the euro and the renminbi as principal reserve currencies, even in their own vicinity.


The renminbi is not fully convertible, and China’s capital controls make it difficult for foreigners to hold the onshore version. A bigger problem is that as yet China does not have a tradable renminbi-denominated “safe asset.” Central banks typically hold reserves in the form of safe assets denominated in the currency of their choice. But if no tradable safe asset is available, then they must hold currency, which does not bear interest and may be less convenient. While this remains the case, the renminbi’s share of global FX reserves may continue to be low, and Asian countries may continue to rely more on the yen and the dollar than the renminbi.


Prior to the Eurozone crisis, the euro was becoming a serious challenger to the dollar for global reserve supremacy. In particular, the possibility that some Middle Eastern oil producers might start invoicing in euros made holding euros attractive. However, the Eurozone crisis highlighted the euro’s fragility: although the European Central Bank (ECB) promised to do “whatever it takes” to preserve the euro, the possibility remains that one or more countries might leave, triggering a disastrous exchange rate fall.


Despite this, some analysts are now raising again the possibility of the euro replacing the dollar as the currency principally used in oil trading. But there is another obstacle to widespread adoption of the euro as reserve currency. The Eurozone currently produces insufficient safe assets for the euro to replace the dollar as the principal currency for the world’s safe savings. Partly, this is because the legacy of the Eurozone crisis is that the debt of many Eurozone countries is no longer considered “safe.” But it is also because those countries that do produce safe debt, notably Germany, don’t produce enough of it.6


Towards a New Global Monetary System: the IMF’s SDR


While these obstacles remain in place, the dollar’s world reserve currency status appears secure. Meanwhile, there are also calls for a new global monetary system, one that would not depend upon the currency of any nation.7 At the heart of such a system would be a universal trade settlement currency, perhaps based on the IMF’s special drawing rights (SDR) basket.


SDR is an international reserve asset which the IMF allocates to its member countries. However, it is not at present a currency in its own right. Rather, it confers upon the holder a “right to draw” currency issued by any of the IMF’s member countries.8


Originally linked to gold, SDR’s value now is determined by a basket of five currencies—USD, the euro, the Japanese yen, the British pound, and the Chinese renminbi. Since SDR is a reserve asset, not a currency, it also bears interest. The interest rate on SDR is determined in relation to the interest rates on safe assets denominated in the currencies of SDR’s basket.9


Recently, there has been a proposal to make SDR an international currency.10 This would mean a change in the status of the IMF. Currently, it can’t create money, it can only distribute funds it has been given by its member states. But if SDR became a tradable international currency, the IMF would become the world’s central bank, at which other central banks would hold reserve accounts denominated in SDR. Supporters of this scheme say that a principal benefit of using SDR as the world’s reserve currency would be greater stability in the international monetary system, since it would no longer depend on U.S. monetary policy.11 However, a move to SDR from the dollar would need to be carefully planned to minimize swings in the dollar exchange rate and U.S. interest rates.


Perhaps the biggest obstacle to creation of a new monetary system based on SDR might be the need for international cooperation. In today’s turbulent world, it could be difficult for countries to agree to adopt such a scheme.

Could the Dollar be Replaced as the World Reserve Currency? Frances_coppola

The Author

Frances coppola

With 17 years experience in the financial industry, Frances is a highly regarded writer and speaker on banking, finance and economics. She writes regularly for the Financial Times, Forbes and a range of financial industry publications. Her writing has featured in The Economist, the New York Times and the Wall Street Journal. She is a frequent commentator on TV, radio and online news media including the BBC and RT TV.

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