History teaches us that reserve currencies never last for long. As empires rise and fall so too does their currency as a global reserve. It can be argued that poor economics and the resulting demise of a currency can bring about the demise of the empire itself. New evidence suggests that this is true of the Roman Empire. As long ago as 55BC Cicero was raising concerns over the trade deficit. Nothing changes.
But what exactly do we mean when we use the term “reserve currency”. A quick poll amongst friends quickly revealed that very few people have any idea. They are aware of the term itself and no more. Wikipedia says “A reserve currency (or anchor currency) is a currency that is held in significant quantities by governments and institutions as part of their foreign exchange reserves, and that is commonly used in international transactions“.
Over the years, many currencies have held this enviable position. If you are British you may well be aware the at the pound sterling was the reserve currency for most of the 19th century and the first half of the 20th century as well. Many have forecast that the inequality of a system that gives such an advantage to the host nation means it will never last for long. It is this inequality that causes nations without the ability to print money at will in order to pay their debts, to push for change. There’s no doubt that the “petro-dollar” an agreement forced on the world by an American deal with Saudi Arabia is an intrinsic part of the American advantage.
It has now been rumoured that Russia is about to finalise a $20 billion trade deal with Iran that specifically excludes the use of the dollar. We know that China has already secured similar trade deals with South America.
Bit by bit the tap is dripping.
Every deal that excludes the dollar is another nail in the coffin for the dollar as the reserve currency, a position it has held since the end of World War II where battle-weary destitute countries had little say in the matter.
Why is it important?
Because as investors we need to know what will replace it. The Yuan maybe? A basket of other currencies?Gold?
Remember there’s a big difference between what we use to trade and what we use as a store of wealth. Therein lies the conundrum facing those who are keen to see the dollar replaced.
Why do fiat currencies (paper money with no asset of value to support them) even have a value you may wonder? What is it that makes a note issued by the government have any value whatsoever in the modern world? The answer is that governments make you pay taxes and they insist that you can only pay your tax bill in the currency of their choice. Here’s the clever bit – only they have the ability to print the currency that you pay with. It’s scam – and its a scam you cannot avoid.