2.4 Global reserve currencies and their roles

Global reserve currencies are the backbone of international finance. They're used by central banks for transactions, investments, and foreign exchange reserves. The US Dollar dominates, followed by the Euro, Yen, and Pound Sterling, with the Chinese Renminbi emerging.

Reserve currency issuers enjoy benefits like lower borrowing costs and geopolitical influence. However, they face challenges such as export pressures and global economic responsibilities. The future may see new reserve currencies emerge, potentially reshaping the international monetary system.

Global Reserve Currencies

Concept of reserve currency

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• Reserve currency held by central banks for international transactions, investments, and foreign exchange reserves
• Functions as medium of exchange for global trade, store of value for monetary authorities, unit of account for pricing (oil, gold), anchor for pegging other currencies (Hong Kong dollar to US dollar)
• Characterized by stability, low inflation, deep financial markets (US Treasury market), strong economic institutions (Federal Reserve)

Major global reserve currencies

• US Dollar dominates with ~60% of global foreign exchange reserves, used extensively in international trade
• Euro follows at ~20%, widely used in European and African countries
• Japanese Yen accounts for ~5%, important in Asian trade and finance
• British Pound Sterling represents ~4%, historically significant and still relevant in global finance
• Chinese Renminbi emerging at ~2%, growing importance reflects China's economic rise
• Other notable currencies include Swiss Franc, Canadian Dollar, Australian Dollar, each playing niche roles in global reserves

Benefits vs challenges for issuers

• Benefits include seigniorage allowing low-cost money printing, lower borrowing costs due to high demand for government securities (US Treasuries), reduced exchange rate risk for domestic firms, enhanced geopolitical influence
• Challenges involve upward pressure on currency value potentially harming exports (strong dollar effect), responsibility to maintain economic stability, vulnerability to external shocks, Triffin Dilemma balancing domestic and international objectives

Potential for new reserve currencies

• Emergence factors: economic growth, financial market development, currency internationalization, geopolitical influence
• Chinese Renminbi gradually internationalizing, included in IMF's Special Drawing Rights basket
• Digital currencies and CBDCs could reshape cross-border transactions and reserves (China's e-CNY)
• Implications: reduced US Dollar dominance, diversified global reserves, multi-polar currency system
• Challenges: building international trust, developing liquid markets, ensuring convertibility, balancing economic objectives