Tag Archives: reserve currency

The Decline of the U.S. Dollar

On his blog for Foreign Policy, Daniel Drezner highlights a recent paper authored by the governor of the central bank of China calling for the development of a new global reserve currency to be administered by the International Monetary Fund. Surprisingly, this story was buried in the Financial Times.  But Drezner rightly points out that a move away from the U.S. dollar as the global reserve currency would have dramatic implications.

Reserve currencies refer to the money held by governments and international institutions as part of their foreign exchange reserves. Reserves serve as the lubricant of international financial transactions and permit countries to barrow money and finance purchases. Since the shift away from species-backed currencies (the U.S. dollar was taken off the gold standard in 1971), the value of currencies has been determined by market forces. Though governments may attempt to manage currency values by buying or selling their own currencies, such efforts are often dramatically unsuccessful— witness the Russian Ruble collapse in 1998, the Asian Financial Crisis in 1997, and so on.

Since the end of World War II, the U.S. dollar has been the global reserve currency. Even today, almost two-thirds of all currency reserves globally are held in U.S. dollars.  The Euro, the second-most widely held currency, accounts for about one-quarter of all reserves, and other currencies, including the Pound sterling, the Japanese yen, and the Swiss franc, round out the remainder.

Because the U.S. dollar has been the global reserve currency, the United States enjoys a number of benefits. Most important of these is the fact that the United States can finance higher trade and budgetary deficits, as it has increasingly done in recent years. A shift away from the U.S. dollar as the global reserve currency would increase the cost of borrowing for the United States and make financing the national debt, which has recently crossed the $10 trillion mark, much more difficult and expensive.

Drezner points out that the shift proposed by China is not likely to happen quickly. Indeed, as the single-largest holder of U.S. dollars, China would be ill-served by a sharp and sudden decline in the value of the dollar. Nevertheless, the issue is likely to occupy decision makers at the upcoming G20 summit. More importantly, it potentially represents the most dramatic shift in the global political economy in decades.