The following is a re-print of my commentary on 20 December 2010 on the McKinsey Quarterly Executive Panel, an online platform:
Coming back to the original question whether any other currency is going to substitute the USD as a reserve currency, we have to be mindful of the word 'subsitute' Along with the USD, the Euro and the Japanese Yen are already held by many central banks as part of a basket of reserve currencies, altough the USD remains the dominant reserve currency.
So the question should be whether this dominant role is likely to be assumed by any substitute currency. Considering the sheer size and influence of the US economy, the current structural problems dogging the Euro and the Yen, and the non-convertibility of the Chinese yuan, I do not see this likely to happen any time soon.
But this is not to say that some 'regional' currencies may not become acceptable as one of the key reserve currencies in a basket so as to dilute the USD dominance. This has become more likely in the light of a tsunami of printed money following successive QEs. Forget about Gold Reserve. All the gold in Fort Knox and elsewhere cannot even match a tiny fraction of this sea of liquidity. It is a no-brainer that large holders of the greenback are likley to seek a measure of risk mitigation.
A likely future candidate for a more balanced basket of reserve currencies is the Chinese yuan, as and when it becomes convertible.
At the moment, China is in what Paul Krugman calls a 'US Dollar Trap', from which any immediate extraction could spell ruin to the Chinese coffers. However, it is no secret that China, along with other surplus countries, is gradually diversifying out of the greenback. Instead of putting so may eggs in a single basket of US Treasuries, more of China's capital is being channeled, through Outward Direct Investment, to acquire overseas assets and resources as well as equity in Western businesses.
What is more, China has been taking vigorous steps to hone the yuan's international acceptability, including trade settlements with her regional trading partners and issuing yuan-denominated bonds, initially in Hong Kong.
For a more detailed analysis of how delicately China manages the Chinese yuan in a turbulent sea of paper money, please visit my research note 'China’s Liquidity Management: A juggling and balancing act' at http://www.andrewleunginternationalconsultants.com/files/chinas-liquidity-management-pdf.pdf
Perhaps in the long run, it is no bad thing NOT to have a single dominant reserve currency, if only to avoid what is termed the 'Triffin Dilemma'. This dilemma was first identified by Belgian-American economist Robert Triffin in the 1960s. He opined that global reserve currency-issuing countries have to suffer large trade deficits in order to supply the world with enough of its currency to fulfill the world demand for foreign exchange reserves. This leads to a conflict of interests as well as tension between national monetary policy and global monetary policy.
Best regards and Merry Christmas,
Andrew K P Leung, SBS, FRSA
Chairman, Andrew Leung international Consultants Limited
www.andrewleunginternationalconsultants.com
