History of World Reserve Currencies

Recently there has been quite a bit of information out there in cyberspace about the potential for the US Dollar to lose its status as the world reserve currency.

What Is A Reserve Currency?

A reserve currency, or anchor currency, is a currency which 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, 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 currency 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 Of Reserve Currencies

Reserve currencies are widely recognized and used for international transactions. From a 1700 – 1900 historical perspective it has been argued by numerous monetary historians that the UK pound, French franc and Dutch guilder in the 1700s were in effect parallel reserve currencies. The fact that money in those times consisted of precious metals and was not printed on notes supports this. In the 1800s a similar picture was in place with the US dollar, Russian ruble, and the unified German Reichmark, being added to the list in the very late 19th century.

However, the modern conception of an international currency as a store of value for the international reserves of central banks and governments is a relatively recent development, arising only in the 19th century coinciding with the emergence of the international gold standard in the decades leading up to the First World War.

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.

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.

Recently, nations, especially in Asia, have been stockpiling reserves at levels previously unknown, especially in US dollars, in an effort to strengthen export competitiveness by weakening their own currencies, and also to contain quick and large inflows of capital and buffer against financial crisis such as the Asian financial crisis.

On June 16, 2009, Russian officials suggested that they may invest more of their reserves in their BRIC partners. However the final BRIC communique did not mention the issue and so the Brazilian real closed lower against the Dollar.

On 7 September 2009, the United Nations conference on Trade and Development issued a report that blamed the dominance of the dollar for playing an important role in the recent build-up of global imbalances.

A brief account of the long history of reserve currencies and draws attention to the interesting phenomenon that, as in the case of the position of a country being the superpower of the world, it seems to be a “natural cycle” of around 100 years long. This has held true ever since the middle of the fifteenth century, with the Portuguese supremacy spanning about 1450-1530 to the Spanish (1530-1640), the Dutch (1640-1720), the French (1720-1815), the British (1815-1920) and the US from then(1920-?).

Potential Replacements As The Reserve Currency

There are several possibilities of a replacement. It could go back to a gold standard, remember that the main reasons the US dollar became the reserve currency was that it was not not only backed by gold,  it was also redeemable in gold.

China’s yuan, known officially as the renminbi could be a contender as well as the Japanese Yen or the Euro, but a more likely scenario than a single currency is the possibility of a basket of currencies called an SDR could be next in line.

So What Are SDRs?
From the International Monetary Fund:

“The SDR is an international reserve asset, created by the IMF in 1969 to supplement the existing official reserves of member countries. The SDR also serves as the unit of account of the IMF and some other international organizations”

Or, in plain English, an SDR (Special Drawing Right) is an artificial, not an actual, currency. SDRs were originally fixed at a rate of 1 Dollar (or 0.888671 grams of fine gold), but now they’re made up of a weighted basket of currencies, currently:

• 44% US Dollar
• 34% Euro
• 11% Japanese Yen
• 11% Sterling

SDRs are often referred to as ‘paper gold’ and are confined to computerized transactions.

References

Wikipedia

What is A Reserve Currency?

The World’s Reserve Currency