The United States Dollar (USD) remains the supreme global currency performing three key functions of an international currency- a unit of account, a medium of exchange and a store of value. Somali pirates want ransom money to be paid (by parachute) in USD. Even trade between two communist or socialist countries is being conducted in USD. The greenbacks account for 85% of all foreign exchange transactions (as two currencies are involved in each transaction, total currencies share amounts to 200 per cent, instead of 100 per cent). Moreover, it remains the most important currency for invoicing and settling international transactions. Almost half of the global stock of international debt securities is denominated in USD. There are two more currencies – the Euro and the Japanese Yen- that plays a similar role of USD, albeit to a lesser extent.
While no single currency is currently in a position to challenge the role of USD, the greenbacks might lose their preeminent position in global trade and finance owing to a number of factors. Given the way the world economy is being restructured – with the United States losing its prominence and some of the large emerging markets gaining. Nevertheless, this is not the only reason that could lead to the declining role of the USD. Who predicted even a few years ago (before the recent financial crisis) that a non-convertible currency such as the Renminbi (RMB, China’s currency) would draw so much global attention? The reason is the fact that the ongoing debt and other economic malaise in America and Europe do not bode well for their currencies. This has accelerated the ascendance of the RMB much earlier than one could have anticipated even a couple of years back. Owing to a number of internal and external factors Beijing has taken several key steps to internationalise its currency.
The rise of emerging market currencies led by RMB could be the single most important phenomenon in global finance in this decade. In the past decade there have been a number of unprecedented developments as far as emerging market currencies are concerned. First, the currencies of most emerging markets have been remarkably stable in the past decade. Many observers call this a ‘paradigm shift’ for emerging markets that earlier saw their currencies losing value vis-à-vis the USD and other major currencies. Second, as observed by UBS, the currencies of emerging markets have substantially outperformed the USD, including interest payments on deposits, since 2001. Third, most emerging markets have independent central banks with explicit inflation targets. Fourth, the rising share of emerging markets in global GDP and their strong economic fundamentals have increased the expectation of currency appreciation in these economies.
Additionally, technology is also facilitating room for multiple international currencies. As Barry Eichengreen of the University of California, Berkeley, notes ‘that not so long ago, there may have been room in the world for only one true international currency. Given the difficulty of comparing prices in different currencies, it made sense for exporters, importers and bond issuers all to quote their prices and invoice their transactions in dollars, if only to avoid confusing their customers. Now, however, nearly everyone carries hand-held devices that can be used to compare prices in different currencies in real time.’
Some argue that the elimination of capital controls has removed the USD’s unique status as the principal medium of exchange in retail markets. Tourists no longer need to have USD travellers’ cheques as credit cards invoiced in other currencies (Brazilian Lira, for instance) are universally accepted.
To sum-up, the potential long term economic decline of US, Japan and Europe, the spectacular rise of the emerging economies, rapid advancement of technology, financial sector reforms around the world might dawn an era for multiple reserve currencies. China may, possibly, lead the way facilitating room for other key emerging market currencies in the not-too-distant future.
The new multiple currency reserve system will be, in all probability, built on four currencies – the US dollar, the euro, the Japanese yen, and the Chinese Renminbi. Among these, the Chinese currency is the only one that is not fully convertible, which it has to be in order to be used as a reserve currency. This, however, could take time. The Chinese have a strong preference for moving with great care when it comes to adopting major changes in the way they manage their economy. They call it ‘crossing the river by feeling the rocks’.
We welcome all comments and feedback at email@example.com.