US Dollars, the Euro, and Sterling – who can take up the slack?

Discussion and Analysis by Charles Porter: 

 

The Dollar, Euro and Sterling are recognised as household names because of their usability, coverage, superior convertibility and relative stability. It will therefore come as no surprise that these three currencies exclusively dominate worldwide foreign exchange reserves. But how long can this pattern continue?

 

A reserve currency should belong to a global economic power and produce stable claims on other currencies and goods across borders. A clear condition for an international reserve currency is, therefore, political and economic stability. Given the tumult within the UK and Eurozone generated by Brexit, and the tripartite confusion within the US following Trump’s Afghanistan, North Korean and Charlottesville episodes, this stability is being drawn into question. Sterling alone, for example, witnessed a sharp and immediate fall following the June 2016 referendum. This event caused Sterling’s perception as a store of intrinsic value to deteriorate, likely undermining its popularity as a reserve currency. Declining perception and confidence in stability caused Sterling’s rapid devaluation and the associated S&P ratings downgrade, foreboding “less predictable” times.

 

The International Monetary Fund continues to report healthy reserve holdings within these three currencies. However, should even one of these currencies have escaped this confusion, it is likely that they would have benefited from a development of their relative reserve status. Crucially, the demarcation of a currency as a reserve confers upon it a surplus value. Enhanced currency value is derived from the dominant market perception of the currency as a credible conduit to preserve wealth.

 

Therefore, it is possible that either a vacuum is being created for an alternative reserve currency to begin to compete amongst the incumbent three, or, for one of these three currencies to take up the slack from its rivals. The Japanese Yen has seen a considerable increase in value with respect to the Dollar throughout the period where its share of worldwide reserve currency holdings has increased (Q4 2015-present). This could suggest that if the confusion within the domestic economies of the major reserve currencies continues, then further scope for the revaluation of the Japanese Yen could exist.

 

Alternatively, with the recent classification of the Chinese Renminbi within this “elite club”, the composition of reserve currencies could be expected to change considerably. Crucially, identifying the direction of the causation, if any, behind this visible trend remains purely speculative. However, opportunities for considerable change in the international values of the world’s most popular currencies are present and pervasive. Further analysis of these opportunities will follow.