FLORENCE -- Fears about sovereign debt and doubts about the euro rescue package have
pushed the question of international reserve currencies to the fore. Until this
spring, most observers had assumed that the share of the dollar in
international reserves would gradually fall, while that of the euro would rise,
and that the world would gradually and smoothly make a transition to a
to now, the global financial crisis was historically remarkable in having no
major impact on foreign-exchange markets. The shares of the major reserve
currencies were stable, with the dollar accounting for 62% of foreign-exchange
reserves in 2009 and the euro 27%. Any major changes came not from deliberate
decisions by central banks to reallocate reserves, but rather from the simple
arithmetic of changing exchange rates: a stronger dollar raised the dollar's
share in total global reserves, while a weaker dollar reduced it.
fact, a sort of balance of terror obstructed any major reallocations by the big
holders of reserves. An effort to diversify by selling a particular asset would
have such a large impact on markets that it would produce large losses for any
central bank that tried it.
euro crisis has challenged the view that the transition to a multi-reserve
regime will have a smooth dynamic. Asian and Middle Eastern central banks with
large euro reserves have become jittery about the euro's political
underpinnings. But America's large fiscal deficit, along with continuing
uncertainty about its financial markets, mean that the dollar is also
are some historical precedents for this situation. In the 1960's, the British
pound was the world's second reserve currency. American policymakers expended
considerable effort devising ways to support the pound, because they knew that
the same factors that made the pound vulnerable also threatened the dollar. The
pound was thus seen as part of the dollar's perimeter defense. Critics saw it
as a case of two lame ducks propping each other up.
recent frenzy of high-level telephone diplomacy, in which US President Barack
Obama pressed European leaders to act to rescue the euro, showed this dynamic
to be alive and well. It was an extraordinary demonstration not only of how
difficult European leaders found coordinating their response to the crisis to
be, but also of the strategic importance of a second reserve currency for the
largest reserve currency. The US economy would be highly vulnerable in the case
of a euro collapse, so today's lame ducks need to embrace each other.
1960's analogy raises the question of whether and when a new major
international currency could emerge. Within the space of a few years, the
pound's reign as a trusted international currency was over. The yen and the
Deutschemark emerged as new potential reserve currencies, although the Japanese
and German governments and central banks were profoundly worried about this new
role for their currencies and the volatility that it might entail.
retrospect, many people have cast the shift as inevitable, but at the time it
seemed wildly improbable. The rise of the yen and the Deutschemark occurred
only 20 years after the catastrophic devastation of World War II, which had
inevitably been accompanied by inflation. During the immediate postwar
occupation, US military planners had to impose new currency regimes and central
more extraordinarily, when these new currencies emerged as the new claimants to
reserve status, they had only recently become convertible for current-account
transactions, and capital flows were still restricted. Germany had moved to
current-account convertibility in 1958, but Japan only in 1964. More over,
Japan in particular was not especially wealthy in an international comparison,
and neither country had deep or well-developed capital markets.
one fact really mattered: powerful export performance, with both countries
maintaining large trade surpluses over several years and through different
stages of the economic cycle. This made them appear a source of greater
currency stability than the US and Britain. The buildup of assets associated
with external surpluses, together with continuing export strength, looked like
a guarantee of their currencies. Unlike the dollar and the pound, the yen and
the Deutschemark did not depend on attracting foreign inflows.
course, developing as a potential reserve currency created a substantial vulnerability.
Both Japan and Germany were slow in liberalizing their domestic financial
systems as they tried to limit capital inflows for a substantial period of time
in order to avoid rapid currency appreciation and the consequent erosion of
their export competitiveness.
moved to current-account convertibility in 1996, but retained a substantial
number of controls on capital movements, which have served as a shield against
financial contagion. Are these still needed?
lesson of the 1960's suggests that a fully convertible renminbi could rapidly
become a major international reserve currency. It would be attractive not
simply because the People's Bank of China and other major Chinese institutions
have massive overseas assets, but because China produces goods that the world's
consumers continue to want. The historical experience of Germany and Japan, and
the recent financial turmoil of the big industrialized countries, seems to warn
against such a policy shift.
as a big country, China would not have the vulnerabilities of smaller strong
currencies (the Norwegian krone or the Swiss franc, for example). And, as a
provider of a reserve currency, China would not need to continue its own quest
for reserves, which has been a major contributing factor to global financial
instability. The addition of the renminbi as a possible reserve option would
free today's lame ducks from their forced marriage.
(Harold James is
Professor of History and International Affairs at Princeton University and
Marie Curie Professor of History at the European University Institute,
Florence. His most recent book is The Creation and Destruction of Value: The