Comment [10]

Agree? Disagree? Let us know what you think. Please include your full name with your comment. Comments may be edited.

• A Better Definition of “Reserve Currency”

  In the MGI discussion paper’s investigation into the cost of capital advantage, there is an attempt to isolate the portion of this advantage attributed to the dollar’s reserve currency status. MGI’s methodology in this endeavor consisted of considering only the demand for dollar assets by foreign governments. Considering that several foreign governments hold reserves that are considered by some scholars to far exceed the required levels of reserve adequacy , the MGI definition may be too broad. Whatever the reason for their accumulation (e.g., extra insurance, inability to fine tune trade or capital flows), these excess reserves are often used for investment purposes in vehicles such as sovereign wealth funds. These investments are similar to those held by non-government entities that were excluded from MGI’s consideration. To avoid mixing different types of foreign currency holdings, MGI should restrict the definition of a reserve currency to the following:

  [T]hose funds that serve as a ready source of liquidity in the event of unforeseen disruptions in the funding of a country’s international balance of payment activities .

  Given this definition, MGI has two options for its cost of capital advantage analysis: (1) consider only the portion of dollars demanded by foreign governments that meet reserve adequacy requirements, or (2) consider both foreign government and foreign non-government demand for dollars.

  Reserve Adequacy

  The 2007 PIMCO report outlines four factors that determine reserve adequacy levels. The following list indicates the four factors and the generally accepted thresholds of adequacy: reserve levels expressed in months of imports (3 months), the ratios of reserves to short-term external debt (100%), the ratio of reserves to broad money supply (5-20%), and the ratio of reserves to domestic equity portfolio holdings by foreigners (30%) .

  Excess Reserves

  In 2007, China’s foreign reserves significantly exceeded the adequacy levels indicated in the preceding section according to the PIMCO report. Chinese reserves constituted 15.6 months of imports, 630% of short-term debt, 26% of broad money supply, and 836% of foreign equity holdings . One can conclude that China’s excess reserve levels are being held for purposes outside of those associated with traditional reserve currency roles. These excess reserves are instead used for investment purposes, similar to the funds held by non-government actors. This behavior, although on a lesser scale, is indicative of several Asian and other emerging market governments.

  Recommendations

  1. Better define the term reserve currency especially in the context of determining the cost of capital benefits.

  2. Either exclude the portion of dollars held by foreign governments that exceed reserve adequacy levels or include all dollars held by foreign entities(public and private) during the cost of capital benefit analysis.

  Posted 28 March 2010, 20:41 by Leonard Haidl

• What about returning to the gold standard, since that is the only thing that has kept us from going into debt? I think it’s a good idea, if you ask me. It’s time to actually start thinking, because you guys haven’t been thinking, for a really long time.

  Posted 8 March 2010, 11:37 by Giovanni

• My name is John Nugée, and I work for State Street Global Advisors, an asset management firm, where I have a role which that includes inter alia commenting on the global financial architecture. Consequently your paper on reserve currencies is of great interest to me, and I would like to offer a couple of comments. I should add that they are personal and do not necessarily reflect my firm’s official stance.
  I think the work is impressive and I agree with you that it does not seem to have been done by anyone else before. I am certainly not aware that anyone has tried to quantify the value to a country of issuing a reserve currency in this way. I do observe though that once you have done the detailed calculations, the numbers are relatively small (indeed surprisingly small), and this may explain this to a certain extent – it may simply be that the monetary consequences of issuing a reserve currency are dominated by the non-monetary effects.
  It is here that I feel your paper could be extended. The non-monetary benefits of issuing a reserve currency, which in a nutshell are that the issuer of a reserve currency can pay for its imports with its own paper, and that demand for that paper is strong, remove the main balance of payments constraints faced by other countries: that of the need to finance imports with foreign exchange, and the need to persuade creditors to lend to them if their reserves of foreign exchange runs short. In effect, while for ordinary countries both the FX reserves and the creditworthiness and ability to borrow to replenish them are assets which are in limited supply and need careful husbanding, neither constraint binds on the issuer of the reserve currency.
  The interesting point is that at the start of a country’s period as reserve currency issuer, these are very definitely benefits. But as time passes, they act to reduce the fiscal discipline of the country and become less unequivocally positives. It is as if one could drink all night without ever getting a hangover: one would be tempted to never exercise moderation, until finally one’s liver collapsed. So with a country’s consumption: without the market-imposed constraints that other countries face, a dominant country can find it hard to resist over-consumption “just because they can”.
  Now in some ways this is a good thing. It is part of the dynamics of a reserve currency that the issuing country has to ensure that other countries have easy access to an adequate supply of their currency. This is essential – international operators need to be assured that the availability of the medium of international exchange is not in doubt, and they need to be able to acquire it easily and at reasonable expense. The latter of these conditions is not often a significant issue – it mainly requires the reserve currency to have deep and liquid markets open to international players – but the former can pose challenges, because the issuer of a reserve currency, at least when it first acquires that status, is almost by definition a strong country with a vibrant economy, and such economies often maintain significant current account surpluses.
  This challenge of a surplus country making sure that enough of its currency is available to other nations is by no means trivial, and for example dominated the discussions at Bretton Woods as the post-War financial system was established. The United States emerged in 1945 as incomparably the most powerful economy in the world, with the US dollar the only conceivable choice for the anchor currency for the global financial system, and although I do not have room to revisit the Bretton Woods debate in any detail in an email, it is worth recalling that one of the main questions in front of the Bretton Woods negotiators was how other countries, many of whose economies were in ruins, were to acquire the dollars to be able even to take part in the global economy. If the US continued to run current account surpluses, it would either drain the rest of the world of what tradeable currencies there were, or end up stockpiling gold, or be forced to act as the creditor of last resort to other nations. Both the first two of these would have been highly deflationary for the world economy, while the last of the three was deeply unattractive to the US authorities. The SDR was an incomplete answer to this challenge, and in many ways we still do not have a full solution.
  It is almost as if the status of reserve currency issuer carries within it the seeds of the country’s destruction. The need to run deficits to provide the rest of the world with dollars, plus the ease with which those deficits have been financed, has led the US from a position of huge balance of payments strength to one of great weakness. And it means that as the US loses its position as hegemon, it faces a painful readjustment which may take decades of debt-repayment (arguably, it took the UK 35 years, from the end of the War to 1980 and the abolition of British Exchange Control, to emerge fully from the curse of the sterling area and sterling balances).
  So my thought for you is that the non-financial side of reserve currency status quite possibly dominates the financial side, and perhaps your paper could expand on the small section (eg pages 11 and 27) where you touch on this. It may help explain for example why Germany was so determined not to internationalise the Deutschmark – they feared losing control of their money supply and losing their financial discipline.
  On a more minor point I do slightly take issue with the idea that the US “may question whether its implicit obligations to the global system outweigh its desire to [run policy for domestic ends]” – page 36. I do not think the US has ever questioned whether its international obligations should dominate its domestic need: it has always run policy for the benefits of the US, and almost always either overrides or totally ignores any obligations to the wider community where these conflict with domestic priorities. From John Connolly’s famous quote that “the dollar is our currency but your problem” in 1971, to the abrupt closing of the Gold window (which was in effect, and under the then system, akin to making the dollar unconvertible and breaking an international promise to pay), it has been the exception rather than the rule for the US to exhibit concern for the effects of its policy on others.

  Posted 31 January 2010, 12:35 by John Nugee

• For a historical perspective, I suggest re-reading the works of Jacques Rueff :

  La Crise du capitalisme (1935)

  La Régulation monétaire et le problème institutionnel de la monnaie (1953)

  Le lancinant problème de la balance des paiements (1965)

  Le Péché monétaire de l’Occident (1971)

  Combats pour l’ordre financier (1972)

  La Réforme du système monétaire international (1973)

  For those who do not read French :

  http://www.amazon.com/Monetary-Sin-West-Jacques-Rueff/dp/B0006DYVOC

  http://www.cato.org/pubs/pas/pa016.html

  Posted 27 December 2009, 04:26 by François Glémet

• The most improtant point about any reserve currency is whether it has the capacity to lead the global trade from a defacto eqiuilbrium to a new one.It acts somehow like the molecules that transfer the contents of energy from one system to the other one.And thats how the U.S dollar despite groaning voices from Charles de Gaulle to recent complains of china’s central Banker facilated the trade and dissemination of the most miracleous ways of productions ,new technologies and innovations(and in the last two decades infromation ,thanks to WWW). The U.S dollar done it well through the 20th century !And as U.S dollar loses the strength the U.S will lose its unique Geoplitical status.So as we enter the new Econodynamics equilibrium then there will be either new Geoplitical struggle between great powers or ther well be a short term for chinese show or what…?We know the dollar will soon lose its lustre as U.S economy loses its energising content.Any question thereafter should be ,how in the absence of a central dictum(no doubt U.S dollar played the role) the nation states will play piecfully or will we enter the new era of National rivalry and short term treason and alliance?If the history is man’s memory then the future wouldn’t be promising.

  Posted 20 December 2009, 05:42 by Hamid Reza Fattahi -Journalist

• Seems world doesn’t have an alternative to Dollar presently.
  May be a few years hence Chiniese currency evolves into an answer

  Vinay Saran
  Sr VP
  Hindusthan National Glass
  India

  Posted 20 December 2009, 01:05 by Vinay Saran Sr VP HNGIL India

• The dollar’s safe—as long as the US retains its agenda of inviting talents and providing shelter to them.

  Posted 18 December 2009, 00:32 by Prof. Sunil D. Doke

• Volatility of currencies will continue in the wake of the Global Financial Crisis.
  “Into The Unknown” May 2009 article from The Banker contains a debt table from key nations economic stimulus packages.
  That shows the enormous stimulus to restart global liquidity.
  Inflation and softening are usually the result.
  Currency markets often build reaction over time
  look at 1996 in Asia, 1998 in Russia, and other dramatic currency movements.
  I remember the huge support given to Korean currency during the Asian currency crisis hardly reported in by standard media There have been some rapid AUD movements recently when USD/AUD .98 was close to parity then sunk to about .64 Feb 2009 and then back to .80-.90 range trading around here now.
  Was the Australian economy so weak for a few weeks? or was it a series of unwinding market arrangements and hedging?
  Dramatic Volatility and fluctuations to come and eventually a convergence with Euro likely or China unlikely for stability.
  This might sound crazy but the world markets will want stability and certainty.
  We have not seen government debt levels like this in the last 50 years so this is a time caution.

  Posted 17 December 2009, 19:31 by john obrien

• The point on the dollar’s fate depending on the fiscal policy success is valid, but the relativity with the other major currencies is just as important. The euro is the obvious candidate and my view is the migration towards euro would not be determined solely by how soon and how strong will the eurozone emerge from the crisis but by the world’s perception of its unity. As long as the economic reforms in the EEA will be politicized and contradictory, the euro will not make significant inroads as a serious alternative to the dollar. So far there were very few signs this euro-alignment will be reached soon, and this is why I am a euro pessimist on teh long term

  Posted 17 December 2009, 15:30 by Dan Enachescu

• I am the global head of currency strategy at Brown Brothers Harriman. I think there is another side of the story that these pieces do not pick up. I think about Anne Marie Slaughter’s piece in the Jan -Feb Foreign Affairs, Josef Joffe essay in the Sept-Oct issue (I think) and lastly my book Making Sense of the Dollar: Exposing Dangerous Myths about Trade and Foreign Exchange.

  Yes there is an Economists article about how the world is abandoning the dollar. Newspaper articles about the diversification of reserves and how OPEC may denominate oil in other currencies. What strikes me about those pieces is that they could be found in Q1 1995.

  I would be happy to talk about these issues if it would be helpful.

  Thank you.

  Marc Chandler
  Global head of Currency Strategy
  Brown Brothers Harriman

  Associare Professor
  New York University
  Center for Global Affairs

  Posted 17 December 2009, 10:38 by marc chandler

Commenting is closed for this article.

• Global capital markets: Entering a new era

  New research from the McKinsey Global Institute suggests that the forces fueling growth in financial markets have changed.

• Reform the international monetary system

  Zhou Xiaochuan, China's central bank governor, calls for a new world currency, in a March 2009 speech.

• Peterson Institute for International Studies