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A week seldom goes by without us
reading somewhere that the US dollar is in danger of losing its reserve
currency status. We are now going to argue that the US$ is actually in no
such danger, because it can't lose what it doesn't have.
The US$ became the official
"reserve currency" in 1944 as a result of the Bretton Woods
agreement. Under this agreement, all the major currencies of the world were
to have fixed rates of exchange against the US dollar. The idea was that
participants in the Bretton Woods system would intervene in the foreign
exchange market -- buying/selling their own currency or US$ reserves -- to
keep the actual rate of exchange within 1% of the stipulated rate. For its
part, the US agreed to make the dollar convertible into gold at the fixed
rate of $35/ounce, although the conversion facility was only available to
central banks and governments.
With all the major currencies pegged
to the US$ it made sense for most international trade to be conducted in
dollars and for commodity prices to be quoted in dollars throughout the
world.
In summary, the Bretton Woods
agreement established a system of payments based on the US$, with all
currencies defined in terms of the dollar and with the dollar defined in
terms of gold. Under this system the US$ was the world's reserve currency,
but gold was the ultimate monetary anchor.
For reasons that we won't regurgitate
at this time, the Bretton Woods system was abandoned in the early 1970s in
two stages. First, the US government "closed the gold window", meaning that the US reneged on its commitment to link
the dollar to gold at the fixed rate of $35/ounce. Second, most central banks
stopped trying to maintain fixed exchange rates. The result was an anchorless
monetary system of free-floating currencies that persists to this day.
Well over half of the world's
currency reserves are still US$-denominated, but this is not because the US$
is still the "reserve currency". The accumulation of US$ reserves
over the past decade has mostly been associated with the mercantilist trade
policies of China, Japan, and other Asian governments. This official-sector
accumulation of dollars will continue as long as the political leaders of
these countries believe that they can gain an economic advantage via a weaker
currency. Refer to our article titled "Nobody wants a strong currency" for
additional thoughts on this issue.
Also, a lot of international trade is
still US$-denominated and commodity prices are still generally quoted in
dollars throughout the world, but this happens for reasons of convenience and
efficiency. It doesn't happen because the US$ has something called
"reserve currency status". The fact is that the US$ is by far the
most widely accepted currency in the world.
The upshot is that under the current
monetary system there is no official reserve currency. It therefore isn't
possible for the US$ to become less valuable as a consequence of losing
"reserve currency status".
Steve Saville
www.speculative-investor.com
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