Near the end of the “Life cycle of money, on a historic scale” post, I brought up that US dollar is the world’s main reserve currency.
Before anything, let’s disassemble “reserve currency”. Reserve currency is the one that is stored in large amounts by many governments and is used outside of national borders to trade with other countries. The chance that suddenly its value goes up or down a lot is slim. So, it is looked at as a safe currency. Or safe-haven currency, if trying to speak economic language.
Today, in total there are five reserve currencies: US dollar, euro, British pound sterling, Japanese yen and recently added Chinese yuan. Most governments have the whole collection in their reserves. The US dollar leads. It accounts for about two thirds of the total reserve currencies held by governments. Hence, you want it or not, the dollar comes down to be the main reserve currency. You may wonder who decided that. Answer is partly people, partly circumstances that are beyond control of people.
History, which to certain extent is composed of circumstances, shows that currency of a country with the greatest economic and political power sooner or later becomes the main reserve currency.
A recent example. If you look back, before World War II, Britain had the strongest economy. It also had political influence not only over its numerous dominions and colonies but other countries as well. And at that time pound sterling was the main reserve currency. Sadly, however, the war had crippled Britain’s superiority. As a result, after the war, the pound sterling could not longer afford to be at the top. On the other hand, the US economy, because of its limited participation and continuous supply of food and other necessities to the Allies, went through the roof. This allowed the US dollar to replace the weakened pound sterling. US dollar since then became the most safest and thus the most favored currency.
But is the US dollar falling?
Time is change. To put it short, in the last few years US economic and political dominance has been challenged by China. China, not US, is now the largest trader of goods in the world. In the present days, China also does and says more from the perspective of global politics. On top of that, Chinese currency, yuan, became the fifth reserve currency in April of this year. Now it proudly stands along with the dollar, euro, pound sterling and yen. The thing is, that unlike dollar and all other reserve currencies, it’s backed up by gold. Meaning, yuans cannot be created without also increasing gold reserves. That’s called a gold standard. Compare that to US dollar, which was detached from gold in 1971 when the gold standard was abandoned. From that point onwards, there is no limit to how many dollars can be created. Gold-backed yuan or dollar backed up by nothing, what has more value and therefore safer? Eventually, what would the rest of the world like more?
In addition, China warned that “there can be no conversion of gold-backed yuan to or from US dollars”. Keeping in mind that majority of existing currencies are pegged to the dollar and China is a vital trading partner roughly for the whole world, this must have sent at least some type of painful stimuli to other countries.
All right, a concluding thought. Although US dollar is far from being worthless yet, from the birds’ eye view, it is sliding down from the pedestal.