Reserve currency, the words are everywhere these days when reading
up on the Economic Collapse of the World. Most people do not understand its implications and effects on the economy. I am going to try and explain it
the best I can for everyone who reads this thread.
First of all I would like to point out that even though I do use Wikipedia, I wish I didnt have too. Wikipedia just has the most information in one
place that I could find. I will also site other places and even a High School text book I happen to have.
What is Reserve Currency?
Reserve Currency
A foreign currency held by central banks and other major financial institutions as a means to pay off international debt obligations, or to influence
their domestic exchange rate.
Investopedia Commentary
Currently, the U.S. dollar is the primary reserve currency used by other countries. A very large percentage of commodities such as gold and oil are
usually priced in U.S dollars, causing other countries to hold this currency to pay for these goods. A large debate still continues about whether or
not the U.S. dollar will stay the main reserve currency or if it will shift over to the euro.
Dictionary.com
Or
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.
Wikipedia.com
Basically, It is the currency that countries use to pay debts with each other. With a marginal impact on allowing the country holding the reserve to
get cheaper products from around the globe.
Why is it a bad thing if the USD is no longer the Reserve Currency?
The United States dollar is the most widely-held reserve currency in the world today. Throughout the last decade, an average of two thirds of the
total allocated foreign exchange reserves of countries have been in U.S. dollars. For this reason, the U.S. dollar is said to have "reserve-currency
status", making it somewhat easier for the United States to run higher trade deficits with greatly postponed economic impact (see currency crisis).
Central bank reserves held in dollar-denominated debt, however, are small compared to private holdings of such debt. In the event that non-United
States holders of dollar-denominated assets decided to shift holdings to assets denominated in other currencies, there could be serious consequences
for the U.S. economy. Changes of this kind are rare, and typically change takes place gradually over time; the markets involved adjust
accordingly.
Having the title of Reserve Currency allows the US to have a large part of the global stage and better relations with many foreign countries. To put
it simply: When everyone wants you, everything is easier to obtain.
If this were to change the US would suddenly have a smaller role in the world, strain on trading and higher prices for its citizens.
Why is this happening?
There are two principal causes behind the most recent development. Both have to do with the fact that Europe is becoming more attractive for
international investors compared to the United States. On the one hand, interest rates in Europe and the United States are moving in opposite
directions. "The ECB will continue to raise its key rates next year, whereas interest rates appear to have peaked in the USA," says Joachim Scheide,
an expert on the economy at the Global Economic Institute (IFW) in the northern German city of Kiel. This means that financial investments denominated
in euros are yielding higher interest and are in greater demand internationally, which in turn leads to a rise in the euro.
The prospects for growth are also shifting. The US economy is cooling off. The government recently lowered its 3.3 percent growth forecast for 2007.
If Americans consume less as a result of a decline in foreign capital investment, the United States could even face a prolonged period of more modest
growth.
Spiegel International I highly suggest you read this entire
article to gain a better understanding of today's markets. Also note that the article is from 2006, this has been a long time coming.
What do the current reserves look like?
Please see this graph on Wikipedia for better insight.
Graph
Notice how the Euro has slowly been going up by a few percent each year, as the USD has gone down.
What would happen if the USD suddenly were not the Reserve Currency anymore?
Pessimists are quick to come out of the woodwork whenever a major shift in the financial markets approaches. Many economists and bank analysts,
especially in the United States, believe that the correction will happen very suddenly, with the dollar depreciating by 10 to 30 percent within a
short period of time.
This would inevitably cause an adjustment crisis. Growth rates would plunge worldwide and a global recession, coupled with a drastic jump in
unemployment, could follow.
This doomsday scenario is by no means the majority view. Some experts, especially in Germany, are more optimistic. "The US trade deficit has grown in
the course of a few years," says IFW expert Scheide. "It will also gradually decline over a period of several years."
Scheide expects the dollar to lose another 10 percent in value against the euro in the next five years, a scenario that would be much easier to handle
for the German and European economies. Companies would have sufficient time to adjust to changes in exchange rates. "In that case even an exchange
rate of 1.40 wouldn't be disastrous," said DIW analyst Steinherr.
Spiegel
International
Can you give me some Scenarios so I have a better idea of how this effects me?
The Soft Landing: This scenario doesn't involve any dramatic drop off in the dollar; rather the dollar would slowly depreciate to a more balanced
level. Imported goods (particularly from the Far East) would be more costly for us to purchase. Meanwhile our export economy would slowly revitalize
since our goods will become cheaper and be more in demand with the increased wealth that the people living in developing nations are beginning to
experience. Our trade balance would slowly disappear and higher tax revenues would rebalance the deficit. The threat of outsourcing would slowly turn
around. The domestic stock market would appreciate as a result, in particular large multinational corporations and those within the manufacturing
sector. Smaller (non-multinational) foreign stocks would also do well along with bonds denominated in foreign currency. Larger, dollar reliant
multi-national foreign companies wouldn't fare as well.
The Hard Landing: This would happen when one event creates a chain of events, leading to panic and crash in the financial markets. For instance, a
geopolitical event such as China invading Taiwan could trigger this. Or sudden changes in the market makes a hedge fund go under; leaving exponential
obligations and a huge sell off of assets around the world to fill the gap. Commodities, long term interest rates, and inflation would take off.
Ironically, the rust belt would come alive and become a boom area of the country with its cheap manufacturing capability and attractive asset prices
to overseas buyers. The domestic stock market would crash along with the housing market. Seeking safety, short term debt and money market accounts
would be earning close to nothing. Foreign stocks and foreign denominated bonds would do exceptionally well in light of the immediate event.
Eventually, the results will be the same within the soft landing, but this scenario would be accompanied by more extreme market conditions, panic,
capitulation and pain that would amplify the situation.
Worst Case: This is what Lietaur suggested. This is where the U.S. government takes action that creates artificial market conditions with regulations
and reneges on its obligations to its debt holders around the world. Essentially there would be two dollar's, a foreign and a domestic dollar. It
would spark a new era of global protectionalism and currency restriction. The global economy and financial markets would in a prolonged recession or
depression and the U.S. would experience higher interest rates, deficits, taxes, and the real estate market would bust. Wal-Mart wouldn't have
anything on their shelves because all the foreign goods would be too expensive to buy.
Maine Business
Last one there sounds familiar doesnt it?
Now because the USD is the reserve currency all the bad would happen in the US while Europe would prosper and have its hayday again.
[edit on 5/22/2009 by Tentickles]
