Currency War

A reserve currency (or anchor currency) is a currency which is held in significant quantities by many governments and institutions as part of their foreign exchange reserves. The products, such as oil, gas, etc. are traded in it in the global market.

This permits the issuing country to purchase the commodities at a marginally cheaper rate than other countries, which must exchange their currency with each purchase and pay a transaction cost .It also permits the government issuing the currency to borrow money at a good rate, as there will always be a wider market for that currency than others.

 

History

                After world war ll the international financial system was governed by a formal agreement, the Bretton Woods System. Under this system the US dollar was placed deliberately at the centre of the system, with the guarantee of US government to other central banks that they could sell their US dollar reserves at a fix rate for gold if they do desired. European countries and Japan deliberately devalued their currencies against the dollar in order to boost exports and development.

          In the late 1960s and early 70s the system came apart under pressure from the rising prominence of the other countries, as well as growing deficits in the US. The US dollar remains central due to the lack of competitor currencies.

          Recently, nations, especially in Asia, have been stockpiling reserves at levels previously unknown, especially in US dollars, in an effort to strengthen export competitiveness by weakening their own currencies, and also to contain quick and large inflows of capital and buffer against financial crisis such as the Asian financial crisis.

United States dollar

                Today, the United States dollar is the most important reserve currency in the world. In the last decade, two thirds of the total allocated foreign exchange reserves of countries have been in United States dollars. Due to this reason the United States dollar said to have “status of reserve-currency”, that help the United States to run higher trade deficits with greatly postponed economic impact. Central bank reserves held in dollar-denominated debt, however, are relatively small compared to private holdings of such debt. If foreign holders of dollar-denominated assets decide to shift holdings to assets denominated in other currencies, there could be grave consequences for the US economy. Changes in the structure of the international financial system, however, typically occur only gradually. Thus, a large, sudden shift away from dollar reserve holding is unlikely.

Euro

                The Euro is currently the second most commonly held reserve currency, being approximately a quarter of allocated holdings. After World War ll and the rebuilding of the German economy, the German Deutsch Mark gained the status of the second most important reserve currency after the US dollar. When the Euro was launched in 1999, replacing the Mark and other European currencies, it attained the status of a main reserve currency. Since then its part in official reserves has risen continually as banks seek to diversify their reserves and trade in the euro zone continues to expand.

          According to former Federal Reserve Chairman Alan Greenspan that the Euro could replace the US dollar as the world’s primary reserve currency. It is “absolutely conceivable that the euro will replace the dollar as reserve currency, or will be traded as a similarly important reserve currency.” Econometrical analysis suggests the euro may replace the US dollar (i) if the euro members, including the UK, adopt the Euro by 2020 or (ii) the recent depreciation trend of the dollar persists into the future.”

Petrodollar Warfare

                The phrase petrodollar warfare refers to a hypothesis that a secret thrust of United States foreign policy over recent decades has been the status of the United States dollar as the world’s dominant reserve currency and as the currency in which oil is priced. The term was used by William R. Clark, the author of a book with the same title. The phrase oil currency wars are occasionally used with the same meaning.

          Supporters of this hypothesis believe that the value of the US dollar is determined by the fact that many key commodities (particularly oil and gas) are traded in dollars. They believe that if it changes to another currency, such as the euro, many nations would sell dollars and cause the banks to shift their reserves because they would no longer need dollars to buy oil and gas. This would make the dollar weaker relative to the euro. The core of the hypothesis is that US administrations are greatly motivated by fear of the consequences of a weaker dollar. This motivation is seen as underlying and explaining many aspects of US foreign policy about Iraq.