Sunday, November 16, 2014

Reserve Currency Status Both A Blessing And A Curse

Having the dollar as the world reserve currency is both a blessing and a curse. The world is currently engaged in a massive game of speculation and chance that contains a lot of risk. Political considerations and insider deals between both nations and Central Banks play a big roll in this game. A chart I saw recently touted how the percentage of funds held by foreign governments in dollars has fallen in recent years. Even after many countries have reduced their holdings in dollar reserves the dollar still carries a major wallop and place in the world economy and will effect everyone going forward.

The above chart highlights the size of this issue
Today four major currencies dominate the world stage, they are the pound, the euro, the yen, and of course the dollar. Two of these are in serious trouble, the yen and the euro, and the pound is very vulnerable to contagion. After that, all the remaining currencies of the world still remain small bit players in the over all scheme of things. The status of being deemed the "reserve currency" by which all others are weighed and in someway pegged does not make the dollar infallible or guarantee it will remain strong but the liquidity of such a large market does add a resilience to the American dollar.

For most concerned a stable world currency yields the most benefits. When the dollar is weak consumers pay more for imports but are able to sell and export more goods and services as they become more competitive. When the dollar gains strength the cost of foreign imports drop and the American consumer is the winner, but it has cost to both job creation and hurts the earnings of  large American companies playing on the world stage. All in all this is more or less a self balancing system that does best when fairly stable. Currently a great deal of effort by countries affected most negatively by the dollars wallop have banded together seeking more options and a work around to break the dollars hold.

The way things are structured the dollar is the linchpin of global fiance and has guaranteed itself a place at the table until dethroned. This means that countries like Japan and China which hold a lot of American bonds and thus dollars will be able to offset some of the pain of a weakening national currency. Unfortunately, many countries they are not in such a position, and to make matters worse countries that are mired in debt often have tied or pegged that debt to the dollar. This means a lot of economic pain if the dollar grows stronger for these countries will find themselves under a great deal of pressure just to survive.  

Unstable currency markets can be a precursor to massive shifts in value and a sudden drop in confidence. It is logical to think that in such a situation insiders would be the big winners. The main reason the world has chosen a "reserve currency" is to have some benchmark to peg currency values to and lessen the impulse of countries that have accumulated massive debts to attempt to address their problems by just printing more money, This results in devaluing their currencies but often fails to face the root cause of their problem. Just printing more money is not sustainable and little comfort should be garnered from assets or pensions being pegged to future inflation because promises can be broken and rules rewritten for what is called the greater good.

The collapse of any currency causes wealth to flee both from the country and that currency and temporary to any safe haven in reach. The bottom-line is that while many people go about their daily lives giving little thought to currency valuations they leave themselves open to the whims of those that control, manipulate and play in this important area of the global economy. Ten percentage points higher or lower against a foreign currency can have a great deal of impact on how your net worth stacks up against someone across the world. This rapidly becomes apparent to anyone doing a great deal of travel or buying foreign goods. It also highlights why all of us should be very concerned where we stand when the smoke clears from the currency wars before us. Do not underestimate the forces in play.

  Footnote; Your comments are welcome and encouraged. If you have time please check out the archives for other post that may be of interest. Below is another of several post I have written concerning currencies.


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