Reserve Currency

6 Key excerpts on "Reserve Currency"

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  eBook - ePub

  From Financial Crisis to Global Recovery

  • Padma Desai(Author)
  • 2011(Publication Date)
  • Columbia University Press

    (Publisher)

  11 In the course of analyzing the role of the dollar as a Reserve Currency, Triffin traced not only the replacement of gold by the dollar in that role, but also the constraints that the emergence of the dollar imposed on U.S. policy making. Thus,

  [g]old has long ceased to provide more than a fraction of the minimum requirements for the preservation of adequate reserve and liquidity levels. Most—although not all—countries, however, have shown themselves willing to accumulate a substantial portion of their monetary reserves in the form of foreign exchange—primarily sterling and dollar balances—alongside of gold itself. The trouble with this solution—known as the “gold exchange standard”—is that it is bound … to impart an increasing vulnerability to the world monetary superstructure built upon these so-called key currencies. Indeed, the additions to international liquidity made possible by the system are entirely dependent upon the willingness of the key currency countries to allow their own net reserve position to deteriorate, by letting their short-term liabilities to foreigners grow persistently and indefinitely at a faster pace than their own gold assets.12

  The dollar replaced the sterling and emerged as the Reserve Currency because countries around the world were willing to hold and use dollar-denominated assets for financing their expanding trade. From early on, the dollar has continued to be freely traded in foreign exchange markets, enabling the dollar-denominated IOU holders to freely move out of their holdings should they so choose. The emergence of the dollar as the Reserve Currency replacing gold became final when President Richard Nixon abolished the dollar’s convertibility into gold in 1971.

  The availability of dollars to outsiders as a Reserve Currency, however, has depended on the ability and willingness of the Federal Reserve to issue dollars. On the one hand, if it chooses to adopt a strict monetary policy and release less currency in order to ease inflationary buildup at home, it may fail to meet the demand for dollars in an expanding global economy. On the other hand, if it pumps excess liquidity into the economy as it has done from the end of 2008 till now, it forces outsiders—among them, China—to hold low-yielding dollar assets. This seesaw of the dollar assets in possession of foreigners, the up-and-down fluctuation as a result of U.S. policy requirements, called the Triffin dilemma, has currently begun the phase of a dollar glut and low-yielding dollar assets.

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  Economics of the International Financial System

  • Sukumar Nandi(Author)
  • 2017(Publication Date)
  • Routledge India

    (Publisher)

  Since the late 1950s, many papers have been written on the theme of international reserve, and these come under broadly two categories: The world reserve problem and how the IMF would solve the problem of inadequate world-level liquidity, so that rising trade among the member countries are not adversely affected; the second channel of research continued regarding the optimal level of reserve from the stand point of a single country. The latter problem has assumed importance in view of the floating exchange rate regime established after the collapse of the Bretton Woods Agreement in the early 1970s. There are at least eight reviews of the literature on the subject since 1960 and these are: Clower and Lipsey(1968), Niehans (1970), Salant (1970), Grubel (1970), Williamson (1973), Aizenman and Marion (2003), and Aizenman and Lee (2007).

  Almost all the studies explain that countries hold international reserve so that they can meet sudden temporary excess demand for foreign exchange and/or to meet short-run adjustment in the balance of trade. The central banks often intervene in the foreign reserve market by selling/buying foreign exchange. International reserves are defined to be assets or credits which can be used directly for intervention, or which can be converted into foreign exchange quickly and with certainty. In practice, it has been necessary to pick up arbitrary cut-off point on such a scale, and define international reserve as assets which are acceptable at all times to foreign economic agents (Machlup, 1966). IMF has to forward estimates of international reserve and these estimates have been widely used in literature for different purposes (Clark, 1971; Flanders, 1971; Kelly, 1970).

  A country can have international reserve at the macro level and also private liabilities towards foreign exchange. Some authors consider whether international reserve should be adjusted for such private liabilities (Brown, 1964; Kenen and Yudin, 1967). In the monetary theory literature, portfolio theory and financial intermediation have been developed and these tools have been used to explain the movement of international reserve in Kane (1965). Such a framework has some relevance with the discussion in Machlup (1966) and the studies of reserve assets composition (Hageman, 1969; Kenen, 1963). The portfolio model employed in Hageman computed stock-adjustment equation for 11 major countries on quarterly data of the 1950s and early 1960 and the study found good evidence that adjustment was far from instantaneous.

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  International Monetary Reform

  A Specific Set of Proposals

  • John Williamson(Author)
  • 2015(Publication Date)
  • Routledge

    (Publisher)

  6  The question of reserves

  It is usual to classify the features of an international monetary system into the arrangements for adjusting balance of payments positions, on the one hand, versus what countries hold when payments are unbalanced, on the other. Adjustment was dealt with in the previous two chapters. In this chapter and the next we turn to the other facet, what countries hold when payments are unbalanced. We deal with what is probable in the present chapter and with the author’s dreams in the next.

  Countries with floating currencies typically do not vary their own asset holdings, but rely on the private sector to smooth out fluctuations; however, they still hold some assets, and they could use these to finance temporary imbalances if they so choose. Countries with fixed currencies hold them fixed by virtue of a declared willingness to buy or sell unlimited quantities at the posted prices, which results in their financing of temporary imbalances. Some countries operate a mixed regime, allowing the rate to move on occasion or else choosing to hold the existing rate by varying their own holdings. In all cases any act of varying its own holdings is referred to as intervention.

  Reserves are assets held by central banks in order to be able to intervene in the foreign exchange market in support of the country’s currency. They consist principally of reserve currencies (mainly dollars, secondarily euros, increasingly yuan, and some other currencies held as reserves). In addition, Reserve Positions in the Fund are included (since they can be automatically mobilized when needed); the IMF’s Special Drawing Rights (SDRs), which can also be mobilized when needed; and an historical relic which is sometimes still included though it can neither be used in intervention nor has it been mobilized in support of any currency for many years, gold. All, except obviously dollars and to some extent euros and yuan, have to be swapped into dollars in order to intervene in the foreign exchange market. Such swaps are also routine for Reserve Positions in the Fund and SDRs, while gold would doubtless be welcomed if it were ever offered. There is a widespread view that the composition of reserves is changing toward a multicurrency system in which a greater proportion of reserves will be held in currencies other than the dollar – in particular, in euros and yuan. There is an expectation that the Chinese yuan will emerge as an important Reserve Currency before long.

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  The Foreign Exchange Matrix

  A new framework for understanding currency movements

  • Barbara Rockefeller, Vicki Schmelzer(Authors)
  • 2013(Publication Date)
  • Harriman House

    (Publisher)

  We have no reason to suppose that the necessary conditions for dollar primacy – a very large economy; free, deep and liquid markets; the rule of law (including property rights); political stability, and national security – would change much if China, say, were to surpass the US as a military power, short of invasion and occupation. China has none of those other necessary conditions. If the world were to decide suddenly that the Chinese renminbi would henceforth become the Reserve Currency, we can imagine that some of the conditions would be created, such as deep and liquid markets, but the remaining conditions depend upon political choices (such as the rule of law, property rights, and financial market prices set by markets and not bureaucratic whim).

  Hard vs. soft power

  Political scientists speak of the hard power of the Reserve Currency issuer, which takes the form of being able to run current account deficits and pay lower interest rates on government bond issues, as contrasted with soft power, which takes the form of influence. Some influence is, in fact, pretty hard, as in the application of dollar diplomacy – supporting foreign regimes for the commercial benefit of US companies in places like Latin America, for instance, or to squash ideological opponents. After the end of the Cold War, the ideological motivation was less in play. The American sphere of influence has shifted from the military threat embedded in the Monroe Doctrine (1823) – foreigners, stay out of the Americas – to more economic, cultural and political types of influence. At the far end of the spectrum, but not trivial, is application of US soft power preventing the loud and often rude complaints about US policy decisions that somehow never make it into the communiqués of G8 summits.

  One of the costs of being the Reserve Currency issuer is the loss of prestige and credibility under adverse conditions (like the US twin deficits in trade and public finance). Then, as Cornell University Professor of Government Kirshner writes, the long leash becomes a choke collar.

  Although the political and international monetary context is distinct, the experience of sterling illustrates these phenomena. In the 19th and early 20th centuries, the pound served as the international currency of choice, with London as world’s financial hub. During World War II, Britain was able to quite explicitly cash in on its key currency status, employing the sterling area to its advantage, financing billions in military expenditures in ways that would not have been possible without the mechanisms that were already in place as a result of the pound’s long-standing global role.

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  Dilemmas of the Dollar: Economics and Politics of United States International Monetary Policy

  Economics and Politics of United States International Monetary Policy

  • C. Fred Bergsten(Author)
  • 2017(Publication Date)
  • Routledge

    (Publisher)

  Chapter 2 , which adds to the global bias since financial men generally have greater influence on policy in Continental Europe. As a result, price stability may assume more weight in assessing a currency by those whose judgments are most critical than it would in some "objective" and more balanced view of economic targets.

  The historical record supports the conclusion that price stability is an important criterion for a Reserve Currency. Sterling was considered highly stable throughout the pre-1914 period, and the Bank of England was known to be both willing and capable of maintaining such stability.8 British prices have been much less stable in the postwar period, however, and sterling's Reserve Currency role has stagnated.

  The United States, on the other hand, had the best price record of any major country during World War I and the interwar period, when the dollar became a key currency. It had virtually the best record in the early post-World War II period, during which the dollar rose to ascendancy. Relative U.S. price stability was especially marked in the 1958-64 era, when increases in the dollar's roles were greatest. The rapid price increases which began in 1965 and continued into the early 1970s, on the other hand, correlate closely with the growth of foreign official doubt about the dollar, which played a major role in fomenting the crises of both 1967-68 and 1971.

  The Swiss situation again helps prove the point: its franc, the only Continental currency to be widely sought for international use over the years, has maintained a better price record—both over the long sweep of history and more recently as well—than any other currency on the Continent. Absence of a history of stable prices helps to explain why some of the other major European currencies have not previously achieved key currency status. The historical experience of Germany and France, for example, has created reluctance to hold marks or francs, and can probably be overcome only by a quite sustained period of stable prices in each country. The events of May 1968, after ten years of good price performance, would appear to justify such a view with regard to France. Germany has now maintained an impressive degree of price stability for a generation, however. Coupled with its historically determined antipathy toward inflation and the collapse of U.S. price stability in the early 1970s, it now looks the most likely bastion against inflation of any of the major countries.

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  Currency Power

  Understanding Monetary Rivalry

  • Benjamin Cohen(Author)
  • 2015(Publication Date)
  • Princeton University Press

    (Publisher)

  In fact, currency internationalization improves the usefulness of money in all its roles. International standing enhances a currency’s value both as a commercial medium of exchange and as a unit of account for the invoicing and settlement of trade; and these effects in turn also broaden its appeal as a store of value, by facilitating accumulation of wealth in assets of more universal purchasing power. At a minimum, it will pay market agents to hold some level of working balances in a popular international currency. Depending on cross-border variations of interest rates and exchange-rate expectations, it will pay them to use it for longer-term investment purposes as well.

  Moreover, once a money comes to be widely used by private actors, it is more likely to be employed by governments too, as a Reserve Currency, intervention medium, and anchor for exchange rates. Public actors too can benefit from the economies of scale offered by a broad transactional network. Historically, the typical pattern of internationalization is adoption first by the private sector, with the public sector then following.

  C HOICES

  Why are there so few international currencies? Within individual countries, the role of a single money can be promoted by the coercive powers of the state. Sovereign governments can deploy legal-tender laws, exchange controls, and related regulatory measures to force residents to make use of the national currency for all legitimate monetary purposes. Inside their borders, states enjoy a de jure monopoly on the creation and management of money. But at the international level, the capacity for coercion is more limited. Compulsion is of course possible in colonial or quasi-imperial clientalistic relationships. But in the more normal case, in relations among independent nations, monopoly is replaced by competition, and actors must be persuaded rather than compelled to make use of one currency rather than another. Rivalry for market share, as a rule, is the essence of the process of internationalization. Typically, to gain standing, a money must be competitive.

  And what makes a money competitive? What determines which currencies will prevail in the Darwinian struggle? The principal qualities required for competitive success are familiar to specialists and hardly controversial. Both economic and political factors appear to be involved.

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