“What does it mean to be the world’s reserve currency?
Everbank’s Chuck Butler sums it up nicely in the following quote:
“Remember, the country with the reserve currency gets to receive loans at discounted borrowing costs. Also, commodities are priced in the reserve currency, meaning central banks around the world must hold the currency in their reserves to facilitate trade.”
“Trading nations need dollars to lubricate trading and as foreign exchange reserves that bolster the value of their own currency and provide the asset base for the expansion of credit within their own nation”
Many different currencies have held reserve status throughout history.
This is important to note because it goes to show that, just like everything else, reserve currency status doesn’t last forever.
At present, the US dollar is the world’s main reserve currency.
That status has been a gift for the US: it has allowed it to run a deficit in perpetuity.
But it has also been a curse:
“The demand for safe assets feeds tha t exorbitant privilege enjoyed by the United States. This contributes to a weakening of US policy discipline as the country tends to excessively rely on easy credit in normal times and very expansionary macroeconomic policies in times of crisis. The outcome is excessive US indebtedness. The corporate sector was in debt prior to the burst of the dot-com bubble in 2001; so were the household and financial sectors before the eruption of the sub-prime crisis in 2007-08; and the official sector is in debt today.”
Let’s assume for a moment that the US recovers, the dollar appreciates in value relative to other currencies, the trade deficit shrinks, and QE comes to end.
That all sounds good, right? Yes, but maybe not for other countries – specifically those with current account deficits.
The end of easy money and artificially low interest rates will not bode well for the emerging markets.
The “faulty five” – aka the “BI ITS” – Brazil, India, Indonesia, Turkey and South Africa are particularly vulnerable because they rely on external financing to operate.
A stronger USD has multiple negative implications for their economies.
Before we continue let’s introduce the idea of Triffin’s Dilemma.
And now for a bit of history…..”Twitter