Is it the end of Dollar as world’s reserve currency?
What is Reserve Currency?
A currency, held in considerable quantities by different governments, as part of their foreign exchange reserves. It is also used for the products traded in global markets such as oil, gold etc. Reserve currency is also called as ‘Anchor Currency’.
US Dollar as Reserve Currency:
Traditionally, US Dollar has been regarded as the reserve currency and for more than 50 years it has been the currency of choice used by various nations of the world to facilitate trade involving commodities such as petroleum, manufactured products and gold. This stature has had tremendous benefits for the U.S. financial system and the consumers, and it has given the U.S. government tremendous power and influence all over the world. Today, more than 60 percent of all foreign currency reserves in the world are in U.S. dollars. The Dollar became so dominant because of the following reasons:
* The ease of availability of derivative instruments to hedge dollar exchange-rate risk and this makes the dollar the most convenient currency for corporations, central banks and governments alike.
* Dollar is world’s safe haven and during the time of crisis investors instinctively returns to it.
* Dollar gained heavily from the dearth of alternatives.
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Threats faced by US Dollar:
There has been a growth of viable alternatives: Euro and Chinese Yuan. With the changing times, market has evolved significantly and today, there is scope for more than one international currency to function simultaneously.
Recently there have been precedents where major oil producing nations have glided away from using dollar and this constitutes a major threat to petrodollar. Apart from this there have been reports from International FI’s like UN and IMF, issuing the need to move away from US Dollar and towards a new world reserve currency.
A lot of this threat emanates from China, world’s 3rd largest economy. Seventy thousand Chinese companies are now doing their cross-border settlements in Yuan and thus freeing themselves from undertaking the foreign exchange transactions. Allowing Chinese banks, for their part, to do international transactions in Yuan will allow them to grab a bigger slice of the global financial pie.
Also, the status of dollar being safe haven is now lost mainly due to the financial crisis and the federal debt approaching 75% of US GDP.
Reasons for decline of US Dollar as Reserve currency:
Dollar Value Share of foreign exchange reserves (percent) http://www.piie.com/blogs/realtime/?p=2805
From the above graph, it is evident that the share of US Dollar as the world’s reserve currency is facing a gradual fall and has come down from 75 % in late 90’s to around 58% in the last quarter of 2011.
The same duration saw growth of Euro as emerging Reserve currency.
Euro Value Share of foreign exchange reserves (percent).
http://www.piie.com/blogs/realtime/?p=2805
Also, last few years have also seen increasing use of Yuan in settling Chinese trade. Following shows the growing trend from the Q1 of 2010 to Q4 of 2011.
http://www.imf.org/external/data.htm
So based on these figures and statistics, we can enumerate some the reasons for the decline of Dollar as Reserve currency.
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1. Dumping of Dollar as the reserve currency used for the trade by the Chinese, Japanese and BRICS nations.
2. Chinese and the Russians have been using their respective currencies for trade.
3. China and UAE have decided to ditch US Dollar and to use their own currencies in oil transactions.
4. Despite sanctions against Iran by the Western world, the trade with Iran continues to be important aspect of many nations. Indian and Iranian deal of payment in Gold for the oil transaction is one such example of that.
5. Increased stress from international institutions like IMF and UN pitching in for the emergence of a new world currency.
6. China is the largest importer of oil from the Saudi Arabia, importing 1.39 million barrels of oil every day. Also there has been considerable Chinese investment in Saudi Arabia for the development of oil refineries. Hence, there is a possibility that this growing partnership will take deal away from petrodollar.
Impact on US Economy:
As the world moves away from US dollar, there will no longer an automatic jump in the value of US Dollar and this will have an adverse impact on the other major economies during the time of volatility surges.
With Dollar, Yuan and Euro being used as Reserve currency, no one currency will rise as strongly as Dollar did.
The impact would be severely faced by the US companies who until now had the convenience of using their currency to pay their workers, importing parts and components, or selling their products to foreign customers. They don’t have to incur the cost of changing foreign-currency earnings into dollars or bear losses due to changes in the exchange rate. This will all change in the brave new world that is coming. American companies will have to cope with some of the same exchange-rate risks and exposures as their foreign competitors.
Conversely, life will become easy for European and Chinese companies and this will lend them competitive advantages.
Another important aspect for US economy would be its failure to finance it budget deficits so cheaply in the event of decline in the demand for the US dollar. Also U.S. will not be able to maintain such large trade and current-account deficits, as financing them will be very expensive.
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Reducing the current-account deficit will trigger increased exports which will make US goods more competitive in the global markets. This would mean that dollar will have to fall in the for-ex markets thereby helping US exporters.
Conclusions:
With the changing financial situations and evolving markets, Dollar is no doubt facing a serious threat in being the reserve currency of the world. However, favourably for US, recent turmoil seen by European markets might have slowed its decline. Still the major threat comes from Yuan. With its stature as emerging power and with its new deals in the oil exporting country, it will soon play a stronger role and will replace petrodollar.
So, the Dollar faces a stiff threat from the Yuan and the coming times might see Yuan emerging as an alternative reserve currency.
References
http://theeconomiccollapseblog.com/archives/10-reasons-why-the-reign-of-the-dollar-as-the-world-reserve-currency-is-about-to-come-to-an-end
http://online.wsj.com/article/SB10001424052748703313304576132170181013248.html
http://www.piie.com/blogs/realtime/?p=2805
http://www.imf.org/external/data.htm
