The geopolitical clashes between China and the West especially in the past few months have highlighted the perils of harbouring and championing global ambitions. The rewards though are certainly handsome.

For a start, any such nations will usually be strong both militarily and economically. As such, their currencies will enjoy supremacy over others, due to their stable nature. The dollar has been the world’s de factor reserve currency since the Bretton Woods agreement, signed in 1944. By then, the US dollar was pegged at USD35 per ounce of gold till August 1971, when the US government decided to abandon the gold standard, mainly due to high inflation and to discourage foreign governments from redeeming more and more dollars for gold.

According to UBS, there are two “reserve” roles. Official foreign exchange reserves are held by central banks, and the dollar dominates. Private foreign exchange reserves are used for invoicing international trade, with the dollar and the euro dominating. Both have become more important invoicing currencies recently.

Official and private reserve currencies have basic characteristics. There must be a steady currency supply—by running a current account deficit (US today), or by widely reinvesting overseas (nineteenth century UK). There must be a large, liquid, low-risk asset market where reserves can be held. Capital controls prevent reserve currency status—users need to get their money on demand. The US freezing Russia’s central bank assets arguably reduced this reserve characteristic. However, freezes like this have happened before; the dollar’s reserve status is safe if investors view US liquidity risk as less than elsewhere.

The recent geopolitical turmoils between the Ukraine and Russia in particular and the wider US-China trade tensions in the last 5 years has seen the US Dollar being used as a financial tool to keep the others in ‘check’, as any transactions in US Dollar will have to pass through the US financial system.

Some analysts have said that such economic sanctions could jeopardise the US dollar hegemony as the world’s reserve currency, by hastening other countries to hedge, diversify and reduce their reliance on the US dollar as their currency reserves.

As of March 2022, China’s PBOC held USD 1.0396 Trillion of US T-bond (US national debt), down from a high of USD 1.1004 Trillion a year earlier. The Bank of Japan on the other hand remains the top major holder of treasury bonds worth USD 1.2324 Trillion as of March 2022, a down from USD 1.2405 Trillion a year earlier.

With the notable exception of the UK (which as the third highest holder) who have steadily increased the purchase of US T-bonds, UK’s holding of US treasury bonds grew steadily from USD 443.1 Billion to USD 634.9 Billion over the same period.

Russia on the other hand, at one point held a high USD 102.5 Billion of US treasury bond in December 2015, but reduced their holding to USD 13.2 Billion at the end of 2018 and held none afterwards.

The implications of holding US treasury bonds are clear, it is a safe financial instrument guaranteed by the most powerful nation at the moment and at least for the foreseeable future. At the same time, it can be worthless if a country is under US economic sanction, such as Russia and Iran.

Thereby, a foreign reserve in US Dollar could be a double-edge sword especially to such countries. Such countries would be best served to diversify their foreign reserves in other major currencies, if not their own, provided that they are themselves economically self reliant and advanced.

China is believed to be headed towards such direction and has implemented several international trades measures settled in RMB and other currencies. Other countries such as Russia and those in the Middle East are also believed to have diversified away from the US dollar.

Certainly it takes a lot more to have one’s currency to be included in the IMF SDR (special drawing rights). The US dollar and Euro continues to be the world’s number 1 and 2 official foreign exchange reserves held by other countries at about 58% and 20% respectively, followed by the Japanese Yen, UK pound-sterling, and Chinese RMB at about 5%, 4%, 3% respectively.

To have one’s currency included as SDR or even better, as replacement to US Dollar and Euro would mean a windfall as they would enable a nation to borrow cheaply.

escveritasBanking & FinanceGlobalInvestment BankingLatest Thinkingcurrency,dollarThe geopolitical clashes between China and the West especially in the past few months have highlighted the perils of harbouring and championing global ambitions. The rewards though are certainly handsome. For a start, any such nations will usually be strong both militarily and economically. As such, their currencies will enjoy...Your Industries Online