Reserve Currency Factors
The U.S. Treasury report points to several key factors identified by economists that determine the use of a currency for reserves:
- the size of the domestic economy
- the importance of the economy in international trade
- the size, depth, and openness of financial markets
- the convertibility of the currency
- the use of the currency as a currency peg
- domestic macroeconomic policies
PIIGS Decimate Euro
Based on these criteria, the euro zone, similar to the United States in size, share of global trade, and currency convertibility, makes the euro a viable contender for the dollar's crown. And in contrast to the dollar, the euro has steadily taken market share regarding global foreign reserves during the past ten years, and has become the second most popular reserve currency. (see graph)
Unfortunately, the debt and budget woes of the PIIGS (Portugal, Italy, Ireland, Greece, and Spain) have seriously damaged the confidence and credibility of the European Union and the euro, essentially decimating the euro's chances as an alternative to the dollar.
The euro has already hit a one-year low against the yen, and nine-month low against the dollar on speculation that Greece's credit rating will be downgraded further. The viability of the European Union and the euro as a going concern has also come into question.
Dollar Reigns Liquidity Supreme
Even without the Greece debacle, the lack of liquidity within the euro zone also makes it difficult to compete against the dollar. One important reason the US dollar remains the reserve currency is that the U.S. treasury market is the most liquid market of its sort. A liquid debt market allows central banks to intervene in foreign exchange markets in order to smooth currency fluctuations.
As noted by the U.S. Treasury Dept. report:
"The euro has not become the dollar's equal as a reserve currency because there is no common sovereign-debt market across the euro zone."
From that perspective, sterling and yen, the next two preferred reserve currencies following the euro, pale in comparison to the dollar in terms of liquidity and facilitating global trade. Moreover, Moody's (MCO) warned of possible downgrades on UK and Japan due to high debt, interest payments and slow GDP growth. (The pound was in virtual free-fall at one stage this Monday and sank to a ten-month low against the dollar on renewed worries about a hung parliament.)
Gold or Yuan?
(Note: You can view every article as one long page if you sign up as an Advocate Member, or higher).
