The concept of a world reserve currency has been around for centuries, some of the more recent countries holding the crown are Portugal (1450-1580), Spain (1530-1640), Netherlands (1640-1720), France (1720-1815), and Great Britain (1815-1944). In 1944, near the end of World War II, the Bretton Woods Agreement established the US Dollar as the world’s reserve currency and it was backed by gold.
In the post-World War II era, the strength of the US economy and military enabled the US dollar to dominate the global financial system. Other currencies were linked to the value of the dollar and international transactions were settled in dollars. This allowed the US to fund its global economic and military aspirations by issuing more dollars than it had in gold reserves.
However, the Bretton Woods system began to unravel in the 1960s when the US persisted with trade deficits while also printing more dollars than they could back with gold. This resulted in lost faith in the dollar and ultimately led to the collapse of the Bretton Woods system in 1971. In the end, US President Richard Nixon announced that the US would no longer exchange dollars for gold at a fixed rate.
Since then, the US dollar has remained the dominant global reserve currency, however that dominance is declining. The volatile US economic environment, political instability, soaring debt levels, low interest rates and weaponization of the currency have led other countries to think of alternatives to the US dollar. But what could replace it?
At this point, it really boils down to 5 choices:
#1 – The Euro. The euro has emerged as a major global currency and has gained importance as a reserve currency. However, it is unlikely to replace the US dollar as the world’s reserve currency in the near term for several reasons:
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- Political fragmentation: The European Union (EU) is a political and economic union of 27 member states, each with its own national interests and priorities. This fragmentation makes it difficult for the EU to speak with a unified voice on global economic issues.
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- Economic instability: The Eurozone has experienced significant economic instability in recent years, with high levels of debt and unemployment in many countries. This has led to concerns about the long-term stability of the euro as a currency.
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- Lack of a unified fiscal policy: While the EU has a single monetary policy under the European Central Bank (ECB), fiscal policy remains the responsibility of individual member states. This lack of a unified fiscal policy makes it difficult for the EU to respond to economic challenges in a coordinated and effective manner.
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- Geopolitical concerns: The EU faces geopolitical challenges, including tensions with Russia and uncertainty about the UK’s relationship with the EU following Brexit. These challenges could make it difficult for the euro to gain global acceptance as a reserve currency.
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- The size of the British economy: While the UK is a major global economy, it is smaller than some of the other major economies, such as the US and China. As a result, the pound may not have the same level of global influence as these larger economies.
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- Political uncertainty: The UK has experienced significant political uncertainty in recent years, including the Brexit process and the pandemic.
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- Limited diversification: While the UK has a well-developed financial sector and a range of financial instruments, its economy is heavily focused on services, particularly financial services. This lack of diversification could make the pound vulnerable to economic shocks.
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- Limited convertibility: China maintains strict controls on the convertibility of its currency, which limits the yuan’s use in international transactions and makes it less attractive as a reserve currency.
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- Lack of transparency: China’s financial system is less transparent than those of many other major economies, which could make investors and central banks hesitant to hold large amounts of yuan.
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- Political concerns: The Chinese government’s control over the economy and its actions on issues such as human rights and trade have raised concerns among some countries.
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- Limited global financial integration: China’s financial markets are still relatively closed to foreign investment, which limits the yuan’s use in international transactions and makes it less attractive.
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- Lack of control: Governments thrive because of their ability to print money and manipulate the money supply. This cannot be done with Bitcoin. There is a fixed supply and creation of bitcoin over time.
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- Volatility: Bitcoin is highly volatile and can experience significant price swings in a short period of time. This volatility makes it difficult for investors and central banks to use Bitcoin as a stable store of value.
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- Limited adoption: While Bitcoin has gained popularity in certain circles, it is still not widely accepted as a means of payment or a store of value.
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- Lack of regulation: Bitcoin is largely unregulated, which could make it vulnerable to fraud, money laundering, and other illicit activities. This lack of regulation could limit its acceptance by central banks and governments.
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- Political fragmentation: Will the countries which make up this basket of currencies share the same political agenda? Will they be fighting amongst themselves?
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- Economic instability: How stable are the respective economies of each country? What is the probability of one or more countries suffering an economic collapse?
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- Lack of trust: Do the other countries around the world trust the government, intentions, economy, and transparency of each country represented in the basket?