Reserve Notice

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People complain, they always do. Back in the now long-ago heyday of the post-Second World War recovery a leading French technocrat (and later President) Valery Giscard D’Estaing commented – or rather, complained – about the US dollar and its reserve currency status. He derided the Greenback’s “exorbitant privilege”, something the US dollar apparently enjoyed even within the strictures of the Bretton Woods gold standard system.

For the world economy during that epoch, the dollar was king. International trade was denominated in the US currency – counterparts preferred to receive, and were obliged to pay, American dollars toward international transactions. This reality at that time amounted to a kind of “seigniorage” – an irreducible economic benefit – for the US currency and economy.

While the Bretton Woods arrangement came undone in 1971, when President Nixon exited the gold standard, the US dollar still managed to flourish, albeit with a floating, market-driven value rather than one fixed against gold. The dollar still managed to thrive because of its recognized “reserve currency” status – again, that term.

Commodities were still priced in US dollars, much of global trade remained denominated in US dollars. The US dollar remained for many a reliable store of wealth as well as a means to exchange.

It’s important to take a quick step back, and ask more pointedly what is a reserve currency? What does it mean? The online service Investopedia actually gives a pretty straightforward and accessible answer, to quote, “A reserve currency is a large quantity of currency maintained by central banks and other major financial institutions to prepare for investments, transactions, and international debt obligations, or to influence their domestic exchange rate…”

So, as Investopedia explains it, a reserve currency amounts to, among other things, some “money in a pinch”, which allows a sovereign to support its own exchange rate during times of stress. The benefits and utility of a reserve currency are manifold: a trusted store of value, an accepted means of exchange, a potential salve during times of economic stress.

And, especially when currencies are no longer linked or interchangeable with gold, reserve currency value resides in the credulity those currency holders demonstrate, both foreign and domestic. A durable reserve currency reflects an implicit vote from the world at large that the underlying national system for that currency works, is reasonably sane, and is conducive to wealth creation.

According to International Monetary Fund statistics, the US dollar continues to predominate, just as it has for all of the post-war period. As of 2019, the dollar made up 60.89% of global central bank foreign exchange reserves, lower than the 65.51% share in 2004 but still the lion’s share. (See the Currency Composition of Official Foreign Exchange Reserves (COFER), which the IMF updates.)

For reference, 20.54% of global central bank forex holding were denominated in EUR, just 5.70% and 4.62% in JPY and Sterling, respectively. What’s striking is the modest presence of the Chinese renminbi (Rmb), which encompassed only 1.96% of global forex reserves, even though China’s economy is the second largest in the world. One wonders if a recalibration should take place.

Of course, now we have the Covid-19 onslaught. In its October 2020 World Economic Outlook, the IMF estimates that global GDP growth will contract -4.4% through the current year, world trade volumes will shrink by -10.4%. Maybe things are recalibrating in the global economy and among the nations in the world. Does correction mean a vote of confidence? Could there be a shift say, in reserve currency status?

Perhaps in some instances or situations, trust and fungibility are, one could say – clumsily but maybe graphically, “orthogonal” to economic correction. Sharp economic corrections can affect levels of trust, but diminished trust and fungibility are not a functional result of any economic crash.

If faith and confidence in arrangements endure, so does that trust, and therefore so does that fungibility. Inflexible capital controls imposed upon the Rmb and China’s capital account say a great deal about lower levels of trust – low levels of trust at least that China’s economic planners have in their own system. In contrast, the proposition of holding USD remains, however, pretty straight forward. Reserve currency configurations should remain roughly the same for a while, even with dislocations from Covid-19 and economic shock.




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