What are “Foreign Exchange Reserves”?

Will the U.S. Dollar Be Replaced as the World’s Reserve Currency?

Foreign Exchange Reserves are foreign money held by International banks for use in international trade and in an effort to diversify their holdings and hedge against the inflation of their own currency. The most common items bought and sold with their foreign exchange reserves are oil and gold. Up until 1944 the asset of choice was gold and it was used as the medium of exchange between countries to settle their debts. But in July 1944, delegates from the 44 Allied nations gathered in Bretton Woods, New Hampshire., and made the U.S. dollar  the reserve currency of the world. At that time, the dollar was pegged at $35 per ounce and thus rather than exchanging gold, the countries were able to exchange dollars, which at the time was considered “as good as gold”.

But because of its reserve status the U.S. was able to pretend that the Dollar was still worth $35 per ounce of gold while quietly inflating its currency and thus eventually France called the United States’ bluff and demanded gold at $35 per ounce and Nixon was forced to admit that the Dollar was no longer worth $35 per ounce and he “closed the gold window” and the last link between the dollar and gold was severed.

But Nixon had another trick up his sleeve and he negotiated a deal with Saudi Arabia requiring that all oil sales be denominated in U.S. dollars, thus establishing a de facto world reserve currency because everyone needed to purchase oil and so they therefore needed dollars.

Why is being the World’s Reserve Currency Important?

Being used as a foreign exchange reserve currency sharply increases the value and usefulness of that currency. When a particular nation’s currency is the de facto reserve currency, that’s nations economic power and influence is automatically spread globally. Like any other commodity the value of the reserve currency is based on supply and demand by rigging an artificially high demand for its currency, the U.S. was able to print more dollars without sparking significant inflation at home. In effect it was able to export its inflation to other oil consuming countries because after it printed them and spent them those dollars went abroad and never returned home so they had no effect on domestic inflation.

Why Might the U.S. Dollar Lose Reserve Currency Status?

The U.S has been the primary world reserve currency since 1944. The nation is no longer the strongest economy and it is beginning to lose its grip on the world’s oil producers and so China and Brazil and other countries are beginning to negotiate oil and other commodity deals denominated in currencies other than the Dollar. This is partially because the value of the dollar has tumbled. The strength of a nation’s economy is primarily based on the relationship between GDP, or the sum of the value of all goods and services produced by the nation, and debt. Stronger economies have higher GDP and lower debt. Over the last few decades the American economy has been moving in the opposite direction, with a stagnant or declining GDP and ballooning debt.  As the world’s reserve currency, countries expect it to retain its value, no one wants to be holding large sums of a currency which might suddenly (or slowly) become worthless.

China is also strategically positioning itself to become a stronger economy than the U.S. By hoarding vast amounts of gold, the nation may soon be able to back its currency, the yuan, with gold, thus skyrocketing the value of that currency. If China’s yuan were to become more valuable than the U.S. dollar it would automatically become the primarily sought form of reserve currency. If current trends continue, China’s economy may become stronger than America’s by all measures as early as 2016. See: Why (and How) China is Boosting the Price of Gold

China is also setting itself up diplomatically to become an enticing foreign exchange reserve currency. No matter the strength of a nation’s economy, the key to its currency’s value is stability and how much inflating the country does to it’s money supply. China realizes this and has been putting the pieces in place to become the world’s reserve currency.

What Does Not Being a Foreign Exchange Reserve Mean for the U.S.?

A loss of reserve currency status is an economic disaster for the U.S. because if dollars are no longer needed to buy oil demand will fall and the value of the dollar will fall with it, that will further cripple the U.S. economy during a time of uncertain recovery. It will make international trade considerably more expensive for the nation, causing a rise in price of all imported goods. If the reserve currency status is lost to China, the economic detriment would be compounded by the fact that the majority of American consumer goods are imported from China. The cost of all Chinese imports would increase dramatically putting further pressure on the U.S. consumer economy.

See Also:

• Banks to Start Holding Gold again as Foreign Exchange Reserves?
• Civil Liberties Rest Upon Sound Money
• Why Buy Gold
• Its Weight in Gold: The Real Prices of Things
• What is Quantitative Easing?
• What to Do When – Not If – Inflation Gets Out of Hand

This article was composed by TJ Barea for the team at kelcreditrepair.com; see their information on local credit services from Craig Lynd.

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