Reserve currency
From Free net encyclopedia
A reserve currency (or anchor currency) is a currency which is held in significant quantities by many governments and institutions as part of their foreign exchange reserves. It also tends to be the international pricing currency for products traded on a global market, such as oil, gold, etc.
This permits the issuing country to purchase the commodities at a marginally cheaper rate than other nations, which must exchange their currency with each purchase and pay a transaction cost. (For major currencies, this transaction cost is negligible with respect to the price of the commodity.) It also permits the government issuing the currency to borrow money at a better rate, as there will always be a larger market for that currency than others.
The United States dollar is the most important reserve currency in the world today. At the end of 2001, 68.3% of the identified official foreign exchange reserves in the world were held in United States dollars, 13% in euros, 4.9% in Japanese yen, 4% in pound sterling and 0.7% in Swiss francs [1]. For this reason, the US dollar is said to have "reserve currency status", making it possible for the United States to run significant trade deficits (financed by seigniorage) with limited economic impact (see currency crisis) as long as the major holders of reserve currencies do not issue public statements suggesting otherwise.
The Pound Sterling was the primary reserve currency of much of the world in the 18th and 19th centuries. But perpetual current account and fiscal deficits financed by cheap credit and unsustainable monetary and fiscal policies to finance wars and colonial ambitions eventually led to the pound sinking.
The G8 also frequently issues public statements as to exchange rates, though with the exception of Japan, the member states are impotent in their ability to directly affect rates. In the past, however, its predecessor bodies could directly manipulate rates to reverse large trade deficits (see Plaza Accord).
The top reserve currency is generally selected by the banking community for the depth, strength, and stability of the economy in which it is used. Thus, as a currency becomes less stable, or its economy shrinks, bankers may abandon it for more stable or deeper economies, although it may take a long time, as recognition is important in determining a reserve currency. For example, it took many years after the United States overtook Great Britain as the financial centre of the world before the dollar became the unquestioned global reserve currency. The Euro and the Renminbi are both candidates to displace the dollar as the predominant reserve currency as their areas of application enlarge (through EU expansion in the case of the euro, and domestic growth in China). The Euro is already the 2nd most commonly traded reserve currency.