Why US Dollar is Still World’s Best Reserve Currency

This article is more or less a summary of my discussions as a member of Economic and Social Council (ECOSOC) in the recently concluded Model United Nations at Mayo College Girls’ School, Ajmer.

The US Dollar’s status as reserve currency is being questioned over and over again. (Pic Source: mymillroad.blogspot.com)

I do not support the US Dollar or the monopoly it enjoys because of  its status as the world’s reserve currency. Before I start, let me tell you that a reserve currency is one which is used in international trade of commodities such as oil, gold, etc. and is also held in significant amounts by other countries of the world.

Going back in time a little, the USD snatched the title of reserve currency from British Pound Sterling after the second World War when it gained the trust of people the world over due to its unmatched stability. Since that time, though its stability is questionable today, the USD has amassed great liquidity which makes it the most ideal reserve currency that we have today. But then, there are so many debates going on in the world about finding an alternative reserve currency. In fact, the International Monetary Fund (IMF) too supports this idea, as is evident through its report Enhancing International Monetary Stability—A Role for the SDR. IMF has suggested that a basket of currencies known as Special Drawing Rights should be taken up as the reserve currency of the world.

Special Drawing Rights

USD clearly leads in the current SDR composition. (Pic Source: huffingtonpost.com)

Now now now, before you start getting ideas about how SDRs would end USD’s monopoly and reign and bring in a reserve currency that would make this world a better place, hold on. As of now, the basket of SDRs has four reserve currencies – USD, Euro, Pound Sterling and Japanese Yen. Do you know on what basis SDRs are allocated to countries? SDRs are allocated on the basis of the SDR Quota of a country. Now if you look carefully, US has 17.69 percent of quota in the SDRs which is way more than any other country. This fact itself will give US a head start if SDRs are ever brought in as reserve currencies.

And if you are asking that why this allocation system cannot be changed, you should know that any change in the allocation system (including additions and subtractions of currencies) requires 85% vote in IMF and the voting power is not one vote per country, it is determined by IMF Quota and…the US once again has 16.75 percent IMF Quota, way more than any other country. So you see, letting USD remain as the reserve currency is as good as shifting to SDRs minus the hassle.

Single New Reserve Currency

The IMF also suggested that a new currency with the name of Bancor should be established to take place of USD as reserve currency and it should be distributed through a World Reserve Bank. This idea is as impractical as it sounds.

Loss of national sovereignty is the most often mentioned disadvantage of monetary union. The transfer of money and fiscal competencies from national to community level, would mean economically strong and stable countries would have to co-operate in the field of economic policy with other, weaker, countries, which are more tolerant to higher inflation. Moreover, establishing a world reserve bank, manufacturing Bancor currency, distributing it in sufficient amounts and forcefully making it the reserve currency would be a highly painful task. Who would control the bank by the way? And how would a reserve currency work when it is not controlled by the GDP of a nation? How would it value/devalue? Once again, USD as a single reserve currency is a better option than a new single reserve currency.

Gold

What about Gold? You must now be thinking that Gold is easily the most stable and suitable reserve currency that our world can have. Even though most countries have gold reserves – with countries like India, China and Mexico increasing theirs – there simply isn’t enough Gold in the world to manage the world’s $60.6 trillion GDP.

Till today we’ve mined about 161,000 tonnes of Gold which is worth about $5.7 trillion, less than half of US GDP! Once again, USD is much better than this alternative.

An existing currency like Euro, Yuan, etc.

No existing currency is as liquid as USD. Liquidity is the most important requirement of an ideal reserve currency, it allows investors to move in and out of the currency without any hassles. Euro is in an even more alarming situation than USD, so it faces a large trust deficit in the world. Talking of Yuan, its situation is laughable as its floating value is as good as nil, it is not convertible.

Conclusion

Reviving the US Dollar may be a tough task, but then it’s possible and needed. (Pic Source: paddypowertrader.com)

It is due to this reason that I, despite not having a lot of affection with the USD, feel that it is the most suitable reserve currency that we have today. And any intelligent economist or investor would know this fact. It is hence naturally suggested that world economies come together and suggest ways to revive US Dollar in its old state and form. What do you think?


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