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Not so long
ago the dollar was the world's only reserve currency. Everything else was one
(or several) steps down in terms of safety and liquidity, and major financial
institutions acted accordingly, accumulating dollars for the risk-free parts
of their portfolios. Global demand for dollars was, as a result, effectively
infinite, which meant the US could borrow whatever
it wanted, secure in the knowledge that the Treasury bonds it created would
find willing buyers.
But quietly,
over the past couple of decades, the dollar has been joined at the top by the
euro, yen, pound sterling and Swiss franc. And now the list of legitimate
reserve currencies has expanded to include Canadian and Australian dollars:
Aussie,
Canada dollars termed reserve currencies
LONDON (MarketWatch) -- The Australian and Canadian dollars, the
world's leading commodity-rich currencies, are being formally classified as
official reserve assets by the International Monetary Fund, marking the onset
of a multi-currency reserve system and a new era in world money.
In a
seemingly innocuous yet highly portentous move, the IMF is asking member
countries from next year to include the Australian and Canadian dollars in
statistics supplied by reserve-holding nations on the make-up of their
central banks' foreign exchange reserves. The technical-sounding measure,
reflecting growing diversification of the world's $10.5 trillion of reserves,
is likely over time to exert wide-ranging impact on world bond and equity
markets.
Expanding by
two the list of officially recognized reserve assets from the present five --
the dollar, euro, sterling, yen and Swiss franc -- signals a new phase in the
development of reserve money. For most of the past 150 years, the world has
had just two reserve currencies, with sterling in the lead until the First
World War, and the dollar taking over as the prime asset during the past 100
years.
Sterling --
although still the world's third reserve currency on IMF figures, just ahead
of the yen -- has been in relative decline since the Second World War. The
birth of the euro in 1999 has turned the European single currency into the
world's No. 2 reserve unit, but it is now officially accepted that the dollar
and the euro share their role with smaller currencies.
Enshrining in
official thinking a development already evident among reserve managers and on
private markets, in a sense, does no more than catch up with reality.
However, the IMF step has both practical and symbolic importance and will
likely promote further asset diversification among official and private asset
managers.
The
popularity among central banks of the Australian and Canadian dollars, which
have been relatively strong even against the firm U.S. dollar during the past
few years, reflect their stable economic growth and intact banking systems
since the financial crisis, as well as the influence of Australian and
Canadian commodity resources. On informal estimates, worldwide official
foreign-exchange holdings in each of the two currencies probably are around
$60 billion.
The Chinese renminbi, the Korean won and the Singapore dollar are
being held by a relatively small number of central banks. There are no Asian
currencies (apart from the yen) on the new IMF list, reflecting their still
very low use as official assets.
The renminbi has attracted widespread attention as a possible
future reverse currency. But it's still some years away from attaining that
status, primarily because it is not fully convertible. Although held in
appreciable quantities by 10 to 15 central banks around the world, the
Chinese money lags as a reserve currency behind not just the Australian and
Canadian units but also some Scandinavian currencies.
People's Bank
of China Gov. Zhou Xiaochuan said at the weekend:
"For the central bank, the next movement related to the yuan [renminbi] is going to be
reform of convertibility ... We are going to realize it, we are moving in
this direction, we need to go further, we will have some deregulation."
Zhou, who
will have completed 10 years at the central bank next month, is widely
expected to retire shortly. The focus will be on how much scope the Chinese
Communist leadership gives his successor to pursue further financial
liberalization.
The
importance of the dollar has diminished, from a peak of 71.5% of declared
reserves in 2001 to just under 62% by 2012. Outside
the five standard reserve currencies, the importance of "other"
currencies has risen, from a low of 1.3% in 2001 to 5.3% by end-June 2012,
amounting to $310 billion.
Some thoughts
Categorizing
Canadian and Australian dollars as reserve currencies makes sense when you
view those countries in terms of gold, oil, sunshine and other resources per
citizen. By that measure, each Canadian and Australian dollar is backed
by a lot more real value than are the currencies of the paper-dependent
societies like the US, Europe and Japan. If, as seems likely, we're in the
early stages of a shift away from financial assets and towards real things,
the relative strength, and currency exchange rates, of the better-run
resource-based economies will keep improving, making their currencies less
risky and more profitable investments.
Note that the
Chinese renminbi (aka the yuan)
and Singapore dollar aren't on the list. But they will be soon, with China
now the second biggest economy (and an aggressive importer of gold) and
Singapore becoming the preferred destination of global savings (especially
gold storage) now that Switzerland has been cracked by the IRS and other tax
authorities. See China's
next step in yuan overhaul is convertibility.
Gold,
meanwhile, is once again being accumulated rather than dumped by central
banks, and has already, arguably, replaced the dollar as the most coveted
reserve asset. This, by the way, is simply a return after a 40-year absence
to the place gold has occupied since the beginning of recorded history.
What does
this mean for the dollar? First, a lot of central banks and trading firms
will sell dollars to buy those other currencies and gold in order to make
their portfolios reflect evolving financial realities. That selling pressure
will, other things being equal, lower the dollar's relative value, which is
another way of saying that the US might not be able to borrow infinite
amounts of money going forward, forcing us to either cut annual deficits far
faster than is currently planned or pay a higher interest rate on future
borrowings, which would increase future deficits.
The US, in
short, will finally be subject to the same economic laws as lesser countries,
with the same result: excessive debt and money printing lead to currency
crisis which leads to depression.
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