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The U.S. dollar is the world’s dominant reserve currency, making up about 64% of all official foreign exchange reserves. The euro is second on the list. The euro had shown decent promise as a reserve currency up until 2009, when it peaked at 28% of global reserves. However, between the European Debt Crisis and years of anemic growth in major European countries, the currency has declined to 20% of official global reserves today. Other currencies held as foreign reserves include British pounds (5%), Japanese yen (4%), Canadian dollars (2%), and Australian dollars (2%). Swiss francs and other currencies make up the remaining 3%. The Chinese yuan also recently won IMF approval to make up part of its Special Drawing Rights (SDR) basket. More and more trade is in Chinese currency, and the country’s bond markets are beginning to grow and internationalize.
The yuan is not a significant player yet, but in the future it may be.
THE RISE OF THE DOLLAR
History has shown that every 100 years or so, the world’s de facto reserve currency has been replaced. The last time this happened was after World War II, when the Bretton Woods system came into effect. Under this system, the U.S. dollar was established as the global anchor currency, linked to gold at a fixed rate. The combination of post-war growth in the U.S. economy along with the official link between dollars and gold provided the international monetary system with a degree of certainty that had been missing for decades. In 1971, Nixon severed the link between the U.S. dollar and gold, but continued U.S. economic and financial strength would keep the dollar prominent on the international monetary stage for decades to come.
WHAT DOES THE FUTURE HOLD?
The video in this post, created by the team at HowMuch.net shows the evolution in acceptance of the greenback. At first, it was U.S. overseas territories such as Guam and the U.S. Virgin Islands that would adopt the dollar. Later in the 20th century, major nations from China to Argentina would attempt to peg their currencies to the dollar for much-needed stability. Will this dollar hegemony continue well into the future? As HowMuch.net notes in its post, it is the size, stability, and liquidity of the country’s financial markets that are the major underlying factors to determine the strength of a reserve currency. While China is now the largest economy in the world in terms of purchasing power, the financial markets of the United States still reign supreme. For example, U.S. stock markets still make up 52% of the total market capitalization of global equity markets. China’s markets are puny in comparison at around 2%. There are signs of a shift in momentum, however. U.S. Treasuries have less liquidity and China has been dumping them on the market. The yuan is officially part of the SDR basket in October 2016, and China could see an inflow of up to $3 trillion in renminbi assets as a result. The yuan has also now passed the yen in terms of cross-border trade volume.