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.
Find Out More About the Status of the World Reserve Currency
Zhou Xiaochuan’s Proposal For World Reserve Currency is Accepted by UN (March 29, 2009)
U.S. Dollar Up For Debate At G8 Meeting (July 5, 2009)
Supracurrency Coin Proposed As New World Reserve Currency (July 12, 2009)
U.S. Dollar Must Be Replaced As The World Reserve Currency (Sept. 8, 2009)
World Bank to U.S.: Don’t Take Reserve Currency Status for Granted (Sept. 27, 2009)
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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{ 9 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
I noticed nary a country has proposed adopting the gold standard again- shows you how addicted we all are to leverage.
Thanks for the comments, everyone. Was recently in England and read quite a bit in their media about China’s financial strategies going ahead. They are definitely making the move away from the US dollar in their reserves. Moving towards buying up companies in resource-rich countries like Canada and Australia.
@Thicken – yes, it’s interesting that the gold standard hasn’t been proposed in this context, isn’t it? That would severely limit what we call economic “growth” today.
@Len – the proposal isn’t about the renminbi… :)
I understand. I kind of veered off and addressed an alternate proposition of my own that has been bandied about. My apologies. :-)
Len
Len Penzo dot Com
No worries. I guess you’re probably talking more about the strength of their economy in general vis a vis the U.S. They certainly are making some pretty bold capitalist moves for a so-called “communist” country (a label I think isn’t valid anymore, at least at the economic level).
i still think that for the dollar, it is the end of an era. the banking industry messed up and otherwise good strong currency. the euro is the next big thing
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.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.