The approaching dearth of reserve currencies
Jan Dehn, head of Research at Ashmore, discusses why in the not-so-distant future the world’s central bankers will have to find alternative global reserve currencies to replace the developed world incumbents.
More than 95% of global foreign exchange reserves are today held in the currencies of the US, the eurozone, UK and Japan. Central banks in these countries have each been tasked with fixing problems that go far beyond what central banks ordinarily do, including raising trend growth rates, reversing unsustainable debt burdens in the public and private sectors and making up for lack of structural reforms in increasingly sclerotic economies.
To their credit, they have acted boldly by pushing interest rates to zero and engaging in the unprecedented printing money sprees we call Quantitative Easing (QE). But it is obvious that they will only be able to meet some of the objectives they have been set. At best, they will succeed in converting their debt problems into inflation problems. But when they do so, the world is likely to wake up to a new and difficult problem – how to find new, healthy currencies to replace the current global reserve currencies.
In private conversation, most Emerging Markets (EM) central bankers will admit that they are extremely worried about the threat posed to their foreign reserve holdings by the easing policies of the reserve currency countries and their governments’ failures to deal with deeper economic problems. The fears are justified. EM central banks hold nearly 80% of the world’s FX reserves and the vast majority is invested in reserve currencies.
Technocrats in EM central banks are well aware that once inflation and currency debasement really take hold in the global reserve currencies, the purchasing power of EM central bank reserves will be decimated. This, of course, is exactly what the US, eurozone, UK and Japan want. By debasing their currencies they are in effect passing the cost of adjustment to foreigners instead of inflicting politically costly austerity on voters at home.
Sadly, EM’s central bankers have been unsuccessful in convincing their political leaders of the dangers ahead and the need to diversify before it is too late. What is perhaps even more remarkable is that EM policy makers appear to have completely failed to grasp the opportunity that lies before them; namely that their own currencies can become part of a brand new breed of global reserve currencies that will be sorely needed in just a few years’ time.