The Rise and Fall of Reserve Currencies
A reserve currency is a currency held in significant quantities by many governments and institutions around the world as a currency for international trade, payments and to support the value of national currencies.
While these reserves used to consist mostly of gold and silver, 1944’s Bretton Woods system expanded acceptable reserves to include the U.S. dollar and other currencies.
Let’s dive into the history of reserve currencies through different time periods, to better understand the role and future of the current main reserve currency: the U.S. Dollar.
The First Currencies
The silver Drachma issued by ancient Athens in the 5th Century B.C. was most likely the first currency that was widely circulated. The gold Aureus and silver Denarius coins issued by Rome were next and they were the dominant currencies from 1st Century B.C. to 4th Century A.D.
Inflation caused major devaluation of the Roman-issued currencies, causing them to become increasingly less accepted making way for the Byzantine Empire’s gold Solidus coin to become the dominant currency in international trade from the 5th Century to 6th Century.
The Arabian Dinar replaced the Solidus as a global trade currency between the 7th to 10th Century. The 13th Century saw Florence issued Fiorino become the dominant trade currency until the 15th Century.
Major Reserve Currencies of Recent History
The Portuguese currency was the dominant trade currency for 80 years between 1450 to 1530 until the Portuguese Succession Crisis caused its downfall.
The Iberian Union saw the Spanish currency becoming the dominant trade currency between 1530 to 1641 (111 years) until the fall of the Iberian Union saw it being replaced.
The rise of the Dutch India trade company saw the currency issued by the Netherlands become the international trade currency. it lasted for 78 years. Netherlands was annexed to France and the French franc circulated. Paper bills began replacing coins at this time.
Anglo Dutch wars saw the currency issued by France become the dominant trade currency. That lasted for 95 years.
As Britain became the dominant trading country with the rise of the British East India Company, the British Pound became the dominant world trade currency. British Banks became the leading financiers of trade and opened branches globally. British shipping companies were leaders in their space and British insurers became the main insurers of trade globally. The decline of the British East India company and the start of World War I saw the share of the pound decline in world trade. The reserve status of the pound lasted 105 years.
US Dollar 1920 till date (98 years so far)
Post World War I, the US dollar became the key trade currency as the US economy played a key role in world trade. The Bretton Woods system in 1944 established a currency regime where the US dollar became the principal reserve currency directly pegged to the price of gold. As a result of that many currencies were linked to the dollar. In the 1970s, US President Richard Nixon released the dollar from its peg, creating the floating currency markets that exist today.
The US Dollar is the main reserve currency today with up to 62% of allocated reserves as of late 2012 (IMF)
The US Dollar Today
There are a number of factors suggesting that, over time, the US dollar may be at risk of surrendering its position as today’s world’s global reserve currency.
Some of these factors relate to U.S. policy decisions, others to policy decisions and developments elsewhere, but all point in the same direction. The primary reason for the dollar’s continued dominance is mainly lack of viable alternatives.
The most obvious U.S. policy contributions to a diminishing role for the dollar are from economic sanctions and protectionist trade initiatives (tarries, attacks on globalism).
While U.S. policies have clearly pushed some countries, such as Iran, Turkey and Russia, away from the dollar, officials in China and the Euro zone have been actively attempting to push their currencies as reserve and transaction substitutes.
More signals of decline..
IMF data reveal the dollar share of foreign reserves fell from a high of 73% in 2001 to 62% at the end of last year. Similarly, central banks bought more gold in 2018 than at any other time since the gold standard ended in 1971 — the World Gold Council confirms- extending a string of large net purchases that began after the global financial crisis.
How to Protect Yourself if the Dollar falls
A dollar collapse would create global economic turmoil. To respond to this kind of uncertainty, you must be mobile. Keep your assets liquid, so you can shift them as needed. Make sure your job skills are transferable.
In such a global economy, where countries ship commodities and goods at an exceeding pace, the fear of markets shaking up due to monetary factors is not going anywhere in the coming years.
The 2008 financial crisis has increased the pressure on the dollar, especially in light of the increasing public debt. Countries without reserve currency status fear that their fates are tied to macroeconomic and political decisions that are outside of their control.
The push for a world market dominated less by the dollar is nothing new, but just as investors seek to hold a basket of investments rather than a single stock, so do central banks when it comes to managing their currency reserves.