A reserve currency, or anchor currency, is a currency In economics, the term currency can refer to a particular currency, for example Pound Sterling, or to the coins and banknotes of a particular currency, which comprise the physical aspects of a nation's money supply. The other part of a nation's money supply consists of money deposited in banks , ownership of which can be transferred by means of which is held in significant quantities by many governments and institutions as part of their foreign exchange reserves Foreign exchange reserves in a strict sense are only the foreign currency deposits and bonds held by central banks and monetary authorities. However, the term in popular usage commonly includes foreign exchange and gold, SDRs and IMF reserve positions. This broader figure is more readily available, but it is more accurately termed official. It also tends to be the international pricing currency for products traded on a global market, such as oil Petroleum or crude oil is a naturally occurring, toxic, flammable liquid consisting of a complex mixture of hydrocarbons of various molecular weights, and other organic compounds, that are found in geologic formations beneath the Earth's surface. Petroleum is recovered mostly through oil drilling. It is refined and separated, most easily by, gold Gold is a chemical element with the symbol Au (from Latin: aurum, "shining dawn", hence adjective, aureate) and an atomic number of 79. It has been a highly sought-after precious metal for coinage, jewelry, and other arts since the beginning of recorded history. The metal occurs as nuggets or grains in rocks, in veins and in alluvial, 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.

Global currency reserves

History

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.^{[citation needed]} 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 A recognized form of exchange can be a form of money or currency, a commodity like gold, or financial capital. To act as a store of value, these forms must be able to be saved and retrieved at a later time, and be predictably useful when retrieved 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 The gold standard is a monetary system in which the standard economic unit of account is a fixed weight of gold. Three distinct kinds of gold standard can be identified. The gold specie standard is a system in which the monetary unit is associated with circulating gold coins, or with the unit of value defined in terms of one particular circulating in the decades leading up to the First World War World War I was a military conflict centered on Europe that began in the summer of 1914. The fighting ended in late 1918. This conflict involved most of the world's great powers, assembled in two opposing alliances: the Allies and the Central Powers. More than 70 million military personnel, including 60 million Europeans, were mobilized in one of.

After World War II Albania · Australia · Austria · Azerbaijan · Belarus · Belgium · Brazil · Bulgaria · Burma · Cambodia · Canada · Ceylon (Sri Lanka) · Channel Islands · China · Czechoslovakia · Denmark · Dutch East Indies · Egypt · Estonia · Finland · France · Germany · Gibraltar · Greece · Greenland · Hong Kong · Hungary · Iceland ·, the international financial system was governed by a formal agreement, the Bretton Woods System The Bretton Woods system of monetary management established the rules for commercial and financial relations among the world's major industrial states in the mid 20th century. The Bretton Woods system was the first example of a fully negotiated monetary order intended to govern monetary relations among independent nation-states. 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 The Triffin dilemma is the observation that when a national currency also serves as an international reserve currency (as the US dollar does today), there are fundamental conflicts of interest between domestic and international economic objectives. This dilemma was first identified by Belgian-American economist Robert Triffin in the 1960s, who, a general problem with any fiat currency The term derives from the Latin fiat, meaning "let it be done", as the money is established by government decree. Where fiat money is used as currency, the term fiat currency is used. Today, most national currencies are fiat currencies, including the US dollar, the euro, and all other reserve currencies, and have been since the Nixon under a fixed exchange regimen, as the dollar was in the Bretton Woods system.

Recently,^[when?] 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 The Asian Financial Crisis was a period of financial crisis that gripped much of Asia beginning in July 1997, and raised fears of a worldwide economic meltdown due to financial contagion.^{[citation needed]}

Theory

Economists debate whether or not a single reserve currency will always dominate the global economy.^[1] Many have recently argued that one currency will almost always dominate due to network externalities In economics and business, a network effect is the effect that one user of a good or service has on the value of that product to other people, especially in the field of invoicing trade and denominating foreign debt securities, meaning that there are strong incentives to conform to the choice that dominates the marketplace. The argument is that, in the absence of sufficiently large shocks, a currency that dominates the marketplace will not lose much ground to challengers.

However, some economists, such as Barry Eichengreen Barry Eichengreen is an American economist who holds the title of George C. Pardee and Helen N. Pardee Professor of Economics and Political Science at the University of California, Berkeley, where he has taught since 1987. Eichengreen's mother is Lucille Eichengreen argue that this is not as true when it comes to the denomination of official reserves because the network externalities are not strong. As long as the currency's market is sufficiently liquid, the benefits of reserve diversification are strong, as it insures against large capital losses. The implication is that the world may well soon begin to move away from a financial system dominated uniquely by the dollar. In the first half of the 20th century multiple currencies did share the status as primary reserve currencies. Although Sterling was the largest currency, both francs and marks shared large portions of the market until the First World War, after which the mark was replaced by dollars. Since the Second World War, the dollar has dominated official reserves, but this is likely a reflection of the unusual domination of the American economy during this period, as well as official discouragement of reserve status from the potential rivals, Germany and Japan.

The top reserve currency is generally selected by the banking Banking is generally a highly regulated industry, and government restrictions on financial activities by banks have varied over time and location. The current set of global bank capital standards are called Basel II. In some countries such as Germany, banks have historically owned major stakes in industrial corporations while in other countries community for the strength and stability of the economy in which it is used. Thus, as a currency becomes less stable, or its economy becomes less dominant, bankers may over time abandon it for a currency issued by a larger or more stable economy. This can take a relatively long time, as recognition is important in determining a reserve currency. For example, it took many years after the United States overtook the UK as the world's largest economy before the dollar overtook Sterling as the dominant global reserve currency.^{[citation needed]}

The G8 The Group of Eight is a forum, created by France in 1975, for governments of six countries in the world: France, Germany, Italy, Japan, the United Kingdom, and the United States. In 1976, Canada joined the group (thus creating the G7). In becoming the G8, the group added Russia in 1997. In addition, the European Union is represented within the G8, also frequently issues public statements as to exchange rates In finance, the exchange rates between two currencies specifies how much one currency is worth in terms of the other. It is the value of a foreign nation’s currency in terms of the home nation’s currency. For example an exchange rate of 91 Japanese yen (JPY, ¥) to the United States dollar (USD, $) means that JPY 91 is worth the same as USD 1, though with the exception of Japan Japan is an island country in East Asia. Located in the Pacific Ocean, it lies to the east of the Sea of Japan, China, North Korea, South Korea and Russia, stretching from the Sea of Okhotsk in the north to the East China Sea and Taiwan in the south. The characters that make up Japan's name mean "sun-origin", which is why Japan is, the member states are impotent in their ability to directly affect rates.^{[clarification needed]} In the past, however, its predecessor bodies could directly manipulate rates to reverse large trade deficits The balance of trade is the difference between the monetary value of exports and imports of output in an economy over a certain period. It is the relationship between a nation's imports and exports. A favourable balance of trade is known as a trade surplus and consists of exporting more than is imported; an unfavourable balance of trade is known (see Plaza Accord The Plaza Accord or Plaza Agreement was an agreement between the governments of France, West Germany, Japan, the United States and the United Kingdom, agreeing to depreciate the US dollar in relation to the Japanese yen and German Deutsche Mark by intervening in currency markets. The five governments signed the accord on September 22, 1985 at the).

United States dollar

The United States dollar The United States dollar is the official currency of the United States. The U.S. dollar is normally abbreviated as the dollar sign, $, or as USD or US$ to distinguish it from other dollar-denominated currencies and from others that use the $ symbol. It is divided into 100 cents 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 ^ b. English is the de facto language of American government and the sole language spoken at home by 80% of Americans age five and older. Spanish is the second most commonly spoken language to run higher trade deficits with greatly postponed economic impact (see currency crisis A currency crisis, which is also called a balance-of-payments crisis, occurs when the value of a currency changes quickly, undermining its ability to serve as a medium of exchange or a store of value. It is a type of financial crisis and is often associated with a real economic crisis. Currency crises can be especially destructive to small open). 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.

However the dollar remains the favorite reserve currency because it has stability along with assets such as United States Treasury security A United States Treasury security is a government debt issued by the United States Department of the Treasury through the Bureau of the Public Debt. Treasury securities are the debt financing instruments of the United States Federal government, and they are often referred to simply as Treasuries. There are four types of marketable treasury that have both scale and liquidity.^[2]

Euro

The euro The euro is the official currency of the Eurozone: 16 of the 27 Member States of the European Union (EU) and is the currency used by the EU institutions. The eurozone consists of Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia and Spain. Estonia is due to is currently the second most commonly held reserve currency, comprising approximately a quarter of allocated holdings. After World War II and the rebuilding of the German A region named Germania, inhabited by several Germanic peoples, has been known and documented before AD 100. Beginning in the 10th century, German territories formed a central part of the Holy Roman Empire, which lasted until 1806. During the 16th century, northern Germany became the centre of the Protestant Reformation. As a modern nation-state, economy (see the Wirtschaftswunder The term Wirtschaftswunder (German for "economic miracle") describes the rapid reconstruction and development of the economies of West Germany and Austria after World War II. The expression was used by The Times in 1950. Beginning with the replacement of the Reichsmark with the Deutsche Mark as legal tender (the schilling was similarly), the German Deutsche Mark The Deutsche Mark was the official currency of West Germany (1948–1990) and Germany (1990–2002) until the adoption of the euro in 2002. It was first issued under Allied occupation in 1948 replacing the Reichsmark, and served as the Federal Republic of Germany's official currency from its founding the following year until 1999, when the Mark gained the status of the second most important reserve currency after the US dollar. When the euro was launched The euro came into existence on the 1 January 1999, although it has been a goal of the European Union and its predecessors since the 1960s. After tough negotiations, particularly due to opposition from the United Kingdom, the Maastricht Treaty entered into force in 1993 with the goal of creating economic and monetary union by 1999 for all EU on January 1, 1999, replacing the Mark, French Franc The franc was a currency of France. Along with the Spanish peseta, it was also a de facto currency used in Andorra (which had no national currency with legal tender). Between 1360 and 1641, it was the name of coins worth 1 livre tournois and it remained in common parlance as a term for this amount of money. It was re-introduced (in decimal form) and ten other European currencies, it inherited the status of a major reserve currency from the Mark. Since then, its contribution to official reserves has risen continually as banks seek to diversify their reserves and trade in the eurozone The eurozone ( pronunciation ), officially the euro area, is an economic and monetary union (EMU) of 16 European Union (EU) member states which have adopted the euro currency as their sole legal tender. It currently consists of Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, continues to expand.^[3] The New York Times Book Review The New York Times Book Review is a weekly paper-magazine supplement to The New York Times in which current non-fiction and fiction books are reviewed. It is one of the most influential and widely read book review publications in the industry. The New York Times has published a book review section since October 10, 1896. The offices are located also referred to the euro as the "Deutsch-Mark by another name".

Former Federal Reserve The Federal Reserve System is the central banking system of the United States. It was created in 1913 with the enactment of the Federal Reserve Act, and was largely a response to a series of financial panics, particularly a severe panic in 1907. Over time, the roles and responsibilities of the Federal Reserve System have expanded and its structure Chairman Alan Greenspan Alan Greenspan is an American economist who served as Chairman of the Federal Reserve of the United States from 1987 to 2006. He currently works as a private advisor and provides consulting for firms through his company, Greenspan Associates LLC. First appointed Federal Reserve chairman by President Ronald Reagan in August 1987, he was reappointed said in September 2007 that the euro could replace the U.S. dollar as the world's primary reserve currency. It is "absolutely conceivable that the euro will replace the dollar as reserve currency, or will be traded as an equally important reserve currency."^[4] Econometric analysis by Jeffery Frankel and Menzie Chinn suggests the euro may replace the U.S. dollar as the major reserve currency by 2020 if: (1) the remaining EU members, including the UK, adopt the Euro by 2020 or (2) the recent depreciation trend of the dollar persists into the future.^[5] In contrast to Greenspan's 2007 assessment the euro's increase in the share of the worldwide currency reserve basket has slowed considerably since the year 2007 and since the beginning of the worldwide credit crunch A credit crunch is a reduction in the general availability of loans (or credit) or a sudden tightening of the conditions required to obtain a loan from the banks. A credit crunch generally involves a reduction in the availability of credit independent of a rise in official interest rates. In such situations, the relationship between credit related recession and sovereign debt crisis. ^[6]

Pound sterling

The United Kingdom's pound sterling The pound sterling , commonly called the pound, is the official currency of the United Kingdom, its Crown dependencies (the Isle of Man and the Channel Islands) and the British Overseas Territories of South Georgia and the South Sandwich Islands, British Antarctic Territory and Tristan da Cunha. It is subdivided into 100 pence (singular: penny) was the primary reserve currency of much of the world in the 18th and 19th centuries. The dire economic cost of fighting the First and Second World Wars, the increasing dominance of the USA in world economics (and, importantly, the establishment of the U.S. Federal Reserve System The Federal Reserve System is the central banking system of the United States. It was created in 1913 with the enactment of the Federal Reserve Act, and was largely a response to a series of financial panics, particularly a severe panic in 1907. Over time, the roles and responsibilities of the Federal Reserve System have expanded and its structure in 1913) as well as economic weakness in the UK at various intervals during the second half of the 20th century resulted in Sterling losing its status as the world's most reserved currency.

As from mid 2006 it is the third most widely held reserve currency, having seen a resurgence in popularity in recent years, but growing from about 2.5% to just below 5% of all currency reserves.^[7] Analysts say this resurgence is caused by carry-trade The carry of an asset is the return obtained from holding it , or the cost of holding it (if negative) (see also Cost of carry) investors considering the pound as a stable high-yield proxy to the Euro.^[8]

Japanese yen

Japan's yen The Japanese yen (sign: ¥; code: JPY) is the official currency of Japan. It is the third most-traded currency in the foreign exchange market after United States dollar and the euro. It is also widely used as a reserve currency after the U.S. dollar, the euro and the pound sterling. As is common when counting in East Asia, large quantities of yen is part of the IMF's Special Drawing Rights Special Drawing Rights are potential claims on the freely usable currencies of International Monetary Fund members. SDRs have the ISO 4217 currency code XDR Valuation. The SDR currency value is determined daily by the IMF The International Monetary Fund is the intergovernmental organization that oversees the global financial system by following the macroeconomic policies of its member countries, in particular those with an impact on exchange rate and the balance of payments. It is an organization formed with a stated objective of stabilizing international exchange, based on the exchange rates of the currencies making up the basket, as quoted at noon at the London market. The valuation basket is reviewed and adjusted every five years.

The SDR Values and yen conversion for government procurement are used by Japan's JETRO for Japan's official procurement in international trade.

Swiss franc

The Swiss franc is often considered a reserve currency, because of the perceived stability of the currency and the Swiss banking system.^{[citation needed]} However, the share of all foreign exchange reserves held in Swiss francs has historically been well below 0.5%. The daily trading market turnover of the franc however, ranked fifth, or about 3.4%, among all currencies in a 2007 survey by the Bank for International Settlements.^[9]

Call for new major reserve currency

Other nations, such as Russia and the People's Republic of China, central banks, and economic analysts and groups, such as the Gulf Cooperation Council, have expressed a desire to see an independent new currency replace the dollar as the reserve currency. China has proposed using the Special Drawing Rights, calculated daily from a basket of U.S. dollar, euro, Japanese yen and British pound, used by the International Monetary Fund for international payments.^[10]

On 3 September 2009, UNCTAD issued a report calling for a new reserve currency based on the SDR, managed by a new global reserve bank.^[11]

The Chinese yuan or renminbi (RMB) cannot be used as a reserve currency as long as the PRC maintains capital controls on the conversion of its currency.^[12] The currency would not be attractive to central banks for holding unless China developed a strong open bond market.^[13]

See also

• Exorbitant privilege
• Foreign exchange reserves
• Hard currency
• Triffin dilemma
• World currency

References

1. ^ Eichengreen, Barry (May 2005). "Sterling's Past, Dollar's Future: Historical Perspectives on Reserve Currency Competition" (PDF). National Bureau of Economic Research (NBER). http://papers.ssrn.com/sol3/papers.cfm?abstract_id=723305.
2. ^ In a world of ugly currencies, the dollar is sitting pretty
3. ^ Lim, Ewe-Ghee (June 2006). "The Euro’s Challenge to the Dollar: Different Views from Economists and Evidence from COFER (Currency Composition of Foreign Exchange Reserves) and Other Data" (PDF). IMF. http://www.imf.org/external/pubs/ft/wp/2006/wp06153.pdf.
4. ^ "Reuters". Euro could replace dollar as top currency - Greenspan. http://www.reuters.com/article/bondsNews/idUSL1771147920070917. Retrieved September 17, 2007.
5. ^ Menzie, Chinn; Jeffery Frankel (January 2006). "Will the Euro Eventually Surpass The Dollar As Leading International Reserve Currency?" (PDF). NBER. http://www.wage.wisc.edu/uploads/Working%20Papers/chinnfrankel_NBER_eurotopcurrency.pdf. Retrieved 2007-10-11.
6. ^ "Currency Composition of Official Foreign Exchange Reserves (COFER) – Updated COFER tables include first quarter 2009 data. June 30, 2009" (PDF). http://www.imf.org/external/np/sta/cofer/eng/cofer.pdf. Retrieved 2009-07-08.
7. ^ Blackden, Richard (2007-01-23). "Sterling surges to 14-year high". The Daily Telegraph. http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2007/01/23/bcnpound23.xml. Retrieved 2007-01-24.
8. ^ "Currency Strategists: Morgan Says Pound Is Euro Proxy". xak.com. Bloomberg. 2006-02-08. http://www.xak.com/main/newsshow.asp?id=56419.
9. ^ "Triennial Central Bank Survey, Foreign exchange and derivatives market activity in 2007". Bank for International Settlements. December 2007. http://www.bis.org/publ/rpfxf07t.pdf.
10. ^ China backs talks on dollar as reserve -Russian source, Reuters, 19 March 2, 2009
11. ^
12. ^ Yuan starts on long slog to reserve currency status
13. ^ Steve LeVine (2009-05-26). "China's Yuan: The Next Reserve Currency?". Business Week. http://www.businessweek.com/globalbiz/content/may2009/gb20090522_665312.htm.

Categories: Currency | Money | Foreign exchange market

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• Reserve Currency: Encyclopedia
• Currencies of Asia
• Currencies of Africa
• Currencies of Europe
• Currency: Dictionary

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