The positioning of a global reserve currency takes decades and centuries. India should not be in a hurry to catapult the Rupee as a reserve currency just yet, as this could put us in an awkward situation with respect to nations who are favourably disposed towards India in the current global geopolitical order.
Even China with a global export share of 14.3% in 2020 has not been successful in establishing the renminbi/yuan as a reserve currency right now. India with a global export share of just 1.6% should not have such aspirations right now. The Indian government should not be in a hurry to fast forward or compress the next 25 years’ economic development in the next one year. From seed to baby born, it takes nine months and you can’t force push the embryo to become a baby in one week. India is on the right track, but our leadership must show patience. Patience in global affairs is a great virtue. One can act in this direction when the Indian economy reaches $20 trillion in 25-30 years’ time. The current Indian leadership should leave some work for the next handful of Prime Ministers in the coming decades. There is talk of strengthening the Rupee vis a vis the US dollar and enabling Rupee trade by opening vostro accounts of other countries in India, which is a step in the right direction, but for the Rupee to become a reserve currency, the current Indian leadership should leave it for the future leaders.Calls for an alternative reserve currency
John Maynard Keynes proposed the bancor, a supranational
currency to be used as unit of account in international trade, as reserve
currency under the Bretton Woods Conference of 1945. The bancor was rejected in
favor of the US dollar. According to some currency specialists, the bitcoin
could become a reserve currency in the future. A report released by the United
Nations Conference on Trade and Development in 2010, called for abandoning the
US dollar as the single major reserve currency. The report states that the new
reserve system should not be based on a single currency or even multiple
national currencies but instead permit the emission of international liquidity
to create a more stable global financial system. Countries such as Russia and
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. However, it is recognized that the
US dollar remains the strongest reserve currency. On 10 July 2009, Russian
President Medvedev proposed a new 'World currency' at the G8 meeting in London
as an alternative reserve currency to replace the dollar. At the beginning of
the 21st century, gold and crude oil were still priced in dollars, which helps
export inflation and has brought complaints about OPEC's policies of managing
oil quotas to maintain dollar price stability.
Special drawing rights
Some have proposed the use of the International Monetary
Fund's (IMF) special drawing rights (SDRs) as a reserve. The value of SDRs are
calculated from a basket determined by the IMF of key international currencies,
which as of 2016 consisted of the United States dollar, euro, renminbi, yen,
and pound sterling. Ahead of a G20 summit in 2009, China distributed a paper
that proposed using SDRs for clearing international payments and eventually as
a reserve currency to replace the US dollar. On 3 September 2009, the United
Nations Conference on Trade and Development (UNCTAD) issued a report calling
for a new reserve currency based on the SDR, managed by a new global reserve
bank. The IMF released a report in February 2011, stating that using SDRs
"could help stabilize the global financial system.
Here’s How Reserve Currencies Have Evolved Over 120 Years
Over the last 120 years, the popularity of different reserve
currencies have ebbed and flowed, reflecting the shifting fortunes of leading
global economies. For example, in the year 1900, the US dollar and pound
sterling made up 0% and 62% of global reserves respectively. But fast forward
to 2020, and the pound now represents just 4.7% of global currency reserves,
while the US dollar stands at nearly 60%.
What is a Reserve Currency?
A reserve currency is a large quantity of currency held in
“reserve” by monetary authorities like central banks. Currencies are often held
in reserve in preparation for investments and transactions, among other things.
Our vast global trade system, which is approaching $20 trillion in value, means
plenty of currencies are always needed in reserve. In fact, an estimated $5
trillion in currency swaps hands every single day. Here are some reasons that
currency reserves are held: Exchange rate stability for the domestic currency, To
ensures liquidity in times of crisis, To diversify central bank portfolios,
which can reduce risk and improve credit ratings, and all things equal,
countries benefit economically from greater demand for their respective
currencies.
A reserve currency (or anchor currency) is a foreign
currency that is held in significant quantities by central banks or other
monetary authorities as part of their foreign exchange reserves. The reserve
currency can be used in international transactions, international investments
and all aspects of the global economy. It is often considered a hard currency
or safe-haven currency. The United Kingdom's pound sterling was the primary
reserve currency of much of the world in the 19th century and first half of the
20th century. However, by the middle of the 20th century, the United States
dollar had become the world's dominant reserve currency. The world's need for
dollars has allowed the United States government to borrow at lower costs,
giving the United States an advantage in excess of US$100 billion per year.
The Rise and Fall of Reserve Currencies
Some economists argue that the demand for currencies in the
long run revolves around the economic relevance of a country. In general, the
larger and more powerful a nation’s economy is, the greater the network effect,
and the more interlinked they are to the global economy. Thus, the greater
demand there is to hold their currency in reserve. The last 120 years of
currency reserve data shows some support for this claim. For example, Japan’s
economy hit a peak in terms of its relative share of global GDP in the early
1990s, just before the effects of the Lost Decade were felt. Subsequently,
their peak as a reserve currency was around the same horizon, at 9.4% in 1990.
America’s Era of Dominance
Due to the economic strength of the United States in the
post-WWII era, the dollar is what economists call a vehicle currency. This
means many non-dollar economies still choose to engage in international
transactions using the dollar. These smaller and less accepted currencies are
often converted to US dollars before proceeding with any business or trade
dealings. This is why, although Asian economies tend to have neighbouring
states as their top trade partners, they still engage in a massive portion of
these transactions with the US greenback as the currency of choice. Here are
some facts that further exemplify the strength and power of the US dollar: More
than 65 countries peg their currencies to the US dollar, Five US territories
and a number of sovereign countries, such as Ecuador and Panama, use it as an
official currency of exchange, Around 90% of all Forex trading involves the US
dollar, additionally, the dollar is often seen as a haven in times of extreme
uncertainty and tumult. Given its status as the world’s reserve currency, it
can be perceived as less risky and can withstand economic shock to a greater
degree relative to other currencies.
Reserve currencies have come and gone with the evolution of
the world’s geopolitical order. International currencies in the past have included
the Greek drachma, coined in the fifth century B.C.E., the Roman denari, the
Byzantine solidus and Islamic dinar of the middle-ages and the French franc. The
Venetian ducat and the Florentine florin became the gold-based currency of
choice between Europe and the Arab world from the 13th to 16th centuries, since
gold was easier than silver to mint in standard sizes and transport over long
distances. It was the Spanish silver dollar, however, which created the first
true global reserve currency recognized in Europe, Asia and the Americas from
the 16th to 19th centuries due to abundant silver supplies from Spanish
America.
While the Dutch guilder was a reserve currency of somewhat
lesser scope, used between Europe and the territories of the Dutch colonial
empire from the 17th to 18th centuries, it was also a silver standard currency
fed with the output of Spanish-American mines flowing through the Spanish
Netherlands. The Dutch, through the Amsterdam Wisselbank (the Bank of
Amsterdam), were also the first to establish a reserve currency whose monetary
unit was stabilized using practices familiar to modern central banking (as
opposed to the Spanish dollar stabilized through American mine output and
Spanish fiat) and which can be considered as the precursor to modern-day
monetary policy.
It was therefore the Dutch which served as the model for
bank money and reserve currencies stabilized by central banks, with the
establishment of Bank of England in 1694 and the Bank of France in the 19th
century. The British pound sterling, in particular, was poised to dislodge the
Spanish dollar's hegemony as the rest of the world transitioned to the gold
standard in the last quarter of the 19th century. At that point, the UK was the
primary exporter of manufactured goods and services, and over 60% of world
trade was invoiced in pounds sterling. British banks were also expanding
overseas; London was the world centre for insurance and commodity markets and
British capital was the leading source of foreign investment around the world;
sterling soon became the standard currency used for international commercial
transactions.
Attempts were made in the interwar period to restore the
gold standard. The British Gold Standard Act reintroduced the gold bullion
standard in 1925, followed by many other countries. This led to relative
stability, followed by deflation, but because the onset of the Great Depression
and other factors, global trade greatly declined and the gold standard fell.
Speculative attacks on the pound forced Britain entirely off the gold standard
in 1931. After World War II, the international financial system was governed by
a formal agreement, the Bretton Woods System. Under this system, the United
States dollar (USD) 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. In the late 1960s and early 1970s,
the system suffered setbacks ostensibly due to problems pointed out by the
Triffin dilemma—the conflict of economic interests that arises between
short-term domestic objectives and long-term international objectives when a
national currency also serves as a world reserve currency.
Additionally, in 1971 US President Richard Nixon suspended
the convertibility of the USD to gold, thus creating a fully fiat global
reserve currency system. However, gold has persisted as a significant reserve
asset since the collapse of the classical gold standard. Following the 2020
economic recession, the IMF opined about the emergence of "A New Bretton
Woods Moment" which could imply the need for a new global reserve currency
system.
Theory on Reserve Currencies
Economists debate whether a single reserve currency will
always dominate the global economy. Many have recently argued that one currency
will almost always dominate due to network externalities (sometimes called
"the network effect"), 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, 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 US dollar. In the first half of
the 20th century, multiple currencies did share the status as primary reserve
currencies. Although the British Sterling was the largest currency, both the
French franc and the German mark shared large portions of the market until the
First World War, after which the mark was replaced by the dollar. 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 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 United Kingdom as the world's largest
economy before the dollar overtook the pound sterling as the dominant global
reserve currency. In 1944, when the US dollar was chosen as the world reference
currency at Bretton Woods, it was only the second currency in global reserves.
The G8 also frequently issues public statements as to exchange rates. In the
past due to the Plaza Accord, its predecessor bodies could directly manipulate
rates to reverse large trade deficits.
Major reserve currencies
United States dollar: The United States dollar is the
most widely held currency in the allocated reserves, representing about 61% of
international foreign currency reserves, which makes it somewhat easier for the
United States to run higher trade deficits with greatly postponed economic
impact or even postponing a currency crisis. Central bank US dollar reserves,
however, are small compared to private holdings of such debt. If non-United
States holders of dollar-denominated assets decided to shift holdings to assets
denominated in other currencies, then there could be serious consequences for
the US economy. Changes of this kind are rare, and typically change takes place
gradually over time, and markets involved adjust accordingly. However, the US
dollar remains the preferred reserve currency because of its stability along
with assets such as United States Treasury security that have both scale and
liquidity. The US dollar's position in global reserves is often questioned
because of the growing share of unallocated reserves, and because of the doubt
regarding dollar stability in the long term. However, in the aftermath of the
financial crisis, the dollar's share in the world's foreign-exchange trades
rose slightly from 85% in 2010 to 87% in 2013. The dollar's role as the
undisputed reserve currency of the world allows the United States to impose
unilateral sanctions against actions performed between other countries, for
example the American fine against BNP Paribas for violations of US sanctions
that were not laws of France or the other countries involved in the
transactions. In 2014, China and Russia signed a 150 billion yuan central bank
liquidity swap line agreement to get around European and American sanctions on
their behaviors.
Euro: The euro is currently the second most commonly
held reserve currency, representing about 21% of international foreign currency
reserves. After World War II and the rebuilding of the German economy, the
German Deutsche Mark gained the status of the second most important reserve
currency after the US dollar. When the euro was introduced on 1 January 1999,
replacing the Mark, French franc 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 continues to expand. After
the euro's share of global official foreign exchange reserves approached 25% as
of year-end 2006 (vs 65% for the US dollar), some experts have predicted that
the euro could replace the dollar as the world's primary reserve currency. However,
as of 2022 none of this has come to fruition due to the European debt crisis
which engulfed the PIIGS countries from 2009 to 2014. Instead, the euro's
stability and future existence was put into doubt, and its share of global
reserves was cut to 19% by year-end 2015 (vs 66% for the USD). As of year-end
2020 these figures stand at 21% for EUR and 59% for USD.
Dutch guilder: The Dutch guilder was the de facto
reserve currency in Europe in 17th and 18th centuries.
Pound sterling: The United Kingdom's pound sterling
was the primary reserve currency of much of the world in the 19th century and
first half of the 20th century. That status ended when the UK almost bankrupted
itself fighting World War I and World War II and its place was taken by the
United States dollar. In the 1950s, 55% of global reserves were still held in
sterling; but the share was 10% lower within 20 years. The establishment of the
US Federal Reserve System in 1913 and the economic vacuum following the World
Wars facilitated the emergence of the United States as an economic superpower. As
of 30 September 2021, the pound sterling represented the fourth largest
proportion (by USD equivalent value) of foreign currency reserves and 4.78% of
those reserves.
Japanese yen: Japan's yen is part of the
International Monetary Fund's (IMF) special drawing rights (SDR) valuation. The
SDR currency value is determined daily by the IMF, 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 the Japan External
Trade Organization for Japan's official procurement in international trade.
Swiss franc: The Swiss franc, despite gaining ground
among the world's foreign-currency reserves and being often used in
denominating foreign loans, cannot be considered as a world reserve currency,
since 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.
Canadian dollar: A number of central banks (and
commercial banks) keep Canadian dollars as a reserve currency. In the economy
of the Americas, the Canadian dollar plays a similar role to that played by the
Australian dollar (AUD) in the Asia-Pacific region. The Canadian dollar (as a
regional reserve currency for banking) has been an important part of the
British, French and Dutch Caribbean states' economies and finance systems since
the 1950s. The Canadian dollar is also held by many central banks in Central
America and South America. It is held in Latin America because of remittances
and international trade in the region. Because Canada's primary foreign-trade
relationship is with the United States, Canadian consumers, economists, and
many businesses primarily define and value the Canadian dollar in terms of the
United States dollar. Thus, by observing how the Canadian dollar floats in terms
of the US dollar, foreign-exchange economists can indirectly observe internal
behaviours and patterns in the US economy that could not be seen by direct
observation. Also, because it is considered a petrodollar, the Canadian dollar
has only fully evolved into a global reserve currency since the 1970s, when it
was floated against all other world currencies. The Canadian dollar, from 2013
to 2017, was ranked fifth among foreign currency reserves in the world,
overtaking Australian Dollar, but is then being overtaken by Chinese Yuan.
Chinese yuan: Chinese yuan officially became a
supplementary forex reserve asset on 1 October 2016. It represents 10.92% of
the IMF's SDR currency basket. The Chinese yuan is the third reserve currency
after the US dollar and euro within the basket of currencies in the SDR. The
SDR itself is only a minuscule fraction of global currency reserves.
New Challengers to the Dollar
In the not too distant past, the US displaced the UK
economically and as the world’s reserve currency. Today, the US economy is
showing signs of slowing down, based on GDP growth. China is on the rise,
having already displaced the US as the EU’s top trade partner. With projections
for China to overtake the US as the world’s largest economy before 2030 in
nominal terms, could a new global reserve currency emerge?
REFERENCES:
Here's
How Reserve Currencies Have Evolved Over 120 Years (visualcapitalist.com)
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