The US Dollar and its Status - Term Paper Example

?The US Dollar will lose its status as the world’s reserve currency within the foreseeable future Table of Contents Introduction 3 US Dollar is losing its status as the world’s reserve currency 3 Conclusion 6 References 6 Bibliography 8 Auerbach, A. J. & Feldstein, M. S. Handbook of public economics, Volume 3. London, UK: Elsevier, 2002. 8 Brown, W. B. & Hogendorn, J. S. International economics: in the age of globalization. USA: University of Toronto Press, 2000. 8 Casson, M. The entrepreneur: an economic theory. London: Edward Elgar, 2003. 8 Gilpin, R. & Gilpin, J. M. International economics: in the age of globalization. USA: Orient Blackswan, 2001. 8 Mankiw, N. G. Principles of Economics. USA: Cengage Learning, 2008. 8 Introduction US Dollar had historically been one of the sturdiest of all currencies around the world. Post World War II, when almost all nations around the world were suffering from dwindling resource endowments, they jointly decided to frame a monetary policy which would tie their respective national currencies with the US Dollar. Such a policy was set in order to strengthen the feeble currencies through tying the rates at which they could be exchanged. However with the passage of time, the stability feature assigned with the US dollars is reckoned to fade away especially after the inception of the Euro zone during late 1990s and after the economy was victimised by the subprime crisis. At present there are many claimants of the fact that the US dollar is about to lose its value as a stable reserve currency. Purpose of the present paper will be to enlist the arguments posed in favour of the aforementioned assertion. US Dollar is losing its status as the world’s reserve currency Euro had been getting closer to the US Dollars in terms of bank note circulation. Since its inception during the latter years of 1990s, the currency is found to be soaring high in terms of popularity especially among the Asian nations where almost two-thirds of total Euro bank notes in circulation are concentrated. The table alongside displays ample information to establish Euro is fast surpassing Dollars in terms of its circulation. To emphasise, stock of Euro has increased by 7 percent between 1999 and 2003 while that of Dollars has receded by 6.7 percent between 2001 and 2006. The diagram alongside shows the extents to which different foreign reserves are found to be growing over the years. Growth in Euro is witnessed as reaching a peak during 2002 and exceeding the corresponding rate for US Dollars (Becker 3). “With the creation of the euro in 1999, and the growth of the US external debt and current account deficits since then, the economic appeal of the dollar as an international currency has become less distinctive” (Helleiner, 367). In fact, during the post Euro era, the position of US dollar has been fast depreciating owing to the fall in its store of value and liquidity. A downfall in the degree of liquidity of the currency accounts for the huge sums of US Dollar reserves that East Asian nations reserve had been maintaining in their reserves; this specifically is the reason behind a fall in the US Dollar circulation (Helleiner, 368). Prior to the introduction of Euro, US Dollars assumed the topmost position in the international arena. This was primarily due to the existence of distinct currencies throughout Europe that transaction via US Dollars was associated with a certain degree of economies of scale. However, after Euro was introduced to the world, a chunk of the world’s important foreign market came to be expressed in terms of Euro and thus, US Dollars lost the economies of scale they used to enjoy previously. An important reason why US Dollars has been diminishing in value in comparison to Euro is that, the latter now represents a chunk of the European continent. This chunk now symbolizes a large unit of the entire global market which is found to be beating that of USA even. Hence, in most of the cases, commodities and services which are available in both markets are denominated in terms of Euro. One of the most important reasons cited behind the currency’s diminishing value is the excessive amount of imports that the parent nation involves itself into. The nation has shifted its position eventually from being an international creditor to that of an international debtor on account of its stance as a net importer of goods and services. Precisely, the nation’s gross indebtedness is more than what the disposable income of all American nationals. Immediately after the Bretton-Woods Commission, USA was assigned the role of propping up the financial positions of economies due to its robust dollar position. However, this very fact was employed by international organisations like IMF and World Bank to coerce USA into indulging in foreign aids and long term foreign investments. However, the nation did not plunge into long term borrowings itself which reduced the nation’s period to pay back thus eventually turning itself into a net borrower (McKinnon, 232). US Dollars remained in its peak state till the late 1990s. In fact, if its position in absolute terms is considered today, the currency would still be found to be assuming the topmost position in context of popularity. However, the importance of Yen and Deutschemark had been rising over the years between 1970 and 1980 as per its shares in aggregate foreign reserves is concerned. But popularity of these two currencies could not beat that of US Dollars back at that time owing to the history of stability that its was associated with. But after Euro, its position deteriorated as the nation’s chronic problem of account deficits and trend depreciation became prominent (Chinn & Frankel, 51). Most of the East Asian nations like China keep their respective currencies depreciated in order togain advantage in terms of trade. This is one of the important reasons why US Dollars are fast receding in circulation. However, as US Dollar value is still quite high, these nations manage to maintain a high value for their respective currencies, despite diversifying their portfolio out of the foreign currency (Chinn & Frankel1, 19). US Dollars are bound to be highly depreciating in their value primarily due to the high volumes of current account deficits which the national government has involved itself into. The primary reason being cited by some critics behind this sharp downfall in value is the strategic mismanagement of the national government at the macroeconomic level. Even though USA has indulged itself into a high amount of current account deficit, the nation rarely makes any attempt to revive itself out of the same. This is the very reason why USA is feared of being plunged into a period of remarkably high inflation in the future which would be corresponded by a huge depreciation of dollar. Many researchers claim the Chinese Yuan to be assuming the post of the lead currency between 2020 and 2040, in the world after US Dollar and a brief reign of the Euro. Japanese Yen could have been a highly prominent choice but it is not believed to take up the position primarily due to the small size of the nation (Eichengreen, 20-22). The rate of exchange of Euro in terms of Japanese Yen is found to be depreciating more than that of US Dollars. This implies that Euro is growing higher in exchange value than US Dollars which is why the number of units of Euro which could be purchased in exchange of 1 unit of Japanese Yen is deteriorating faster than the number of units of US Dollars which could be purchased. In fact, the value of Euro had not been historically as high as US Dollars. But no sooner was it introduced in the market that it took over the position of US Dollars, i.e., within a span of 2 years or to be exact, almost 6 quarters (OANDA Corporation, ‘Average Exchange Rates’). This very fact stands in support of the point that Euro is fast taking over the position of US Dollars. Even though there had been timely fluctuations over time, the position of Euro in terms of US Dollars is found to be improving over time. Rationale behind the choice of Japanese Yen in this case is the extent of stability that the currency has over a set of others. In addition, Japan is one of the nations which attained the fastest developments in the world. Its location amidst the developing East Asian nations is also another factor which guarantees its strong financial stance over the years. However, Japanese Yen cannot be regarded as an able contender of US Dollars due to the extremely small size of the nation and its strategy of being a net exporter. Conclusion The present paper discussed the trends in the value of US Dollars as reserve currency stocks throughout the world. It had been found that the currency is fast receding in value primarily due to the rising importance of Euro. The decline in its position became especially prominent post 1999, when Euro was introduced as the central and fundamental currency of a large region constituting Europe. Since then, most of the world shifted its attention to the Euro. Even though many critics still believe that Japanese Yen as well as Yuan could surpass in terms of the popularity of Euro over the years, majority of them consider Euro to be the most important of all contenders in this field. Euro’s position is fast becoming sturdier as it is gaining importance in terms of rate of exchange against Japanese Yen in comparison to US Dollars. Hence, in any case, it could be asserted that US Dollar will lose its status as the world’s reserve currency within the foreseeable future and the possible currency believed to be taking its position will be Euro. References Becker, W. “Euro riding high as an international reserve currency”. Deutsche Bank Research. 4 May, 2007: 1-20. Chinn, M. & Frankel, J. “Why the Euro Will Rival the Dollar”. International Finance. Vol. 11 (1), 2008: 49 –73 Chinn, M. & Frankel, J.1. “The Euro May Over the Next 15 Years Surpass the Dollar as Leading nternational Currency”. International Finance. 2008: 1-26. Eichengreen, B. “Sterling’s past, Dollar’s future: Historical perspectives on reserve currency competition”. National Bureau of Economic Research. Working Paper 11336. May, 2005: 1-29. Helleiner, E. “Political determinants of international currencies: What future for the US dollar?” Review of International Political Economy. Vol. 15 (3), August, 2008: 354–378 McKinnon, B. “The international Dollar standard and the sustainability of the U.S. current account deficit”. Brookings Paper on Economic Activity. Vol. 1, 2001: 227-239. OANDA Corporation. 18 March, 2011. Average Exchange Rates. 18 March, 2011 . Bibliography Auerbach, A. J. & Feldstein, M. S. Handbook of public economics, Volume 3. London, UK: Elsevier, 2002. Brown, W. B. & Hogendorn, J. S. International economics: in the age of globalization. USA: University of Toronto Press, 2000. Casson, M. The entrepreneur: an economic theory. London: Edward Elgar, 2003. Gaub, P. International Trade China: Coal, Oil and Gas. Norderstedt, Germany: GRIN Verlag, 200. Gilpin, R. & Gilpin, J. M. International economics: in the age of globalization. USA: Orient Blackswan, 2001. Mankiw, N. G. Principles of Economics. USA: Cengage Learning, 2008. USA International Business Publications. Canada Business and Investment Opportunities Yearbook. Washington, D.C.: International Business Publications, 2007. Schaechter, A. Stone, M.R. and Zelmer, M. “Adopting inflation targeting: practical issues for emerging market countries”. International Monetary Fund 2000. http://www.bankofengland.co.uk/publications/speeches/2005/speech245.pdf Read More