ELI5: What is the world’s “reserve currency” and why would it benefit certain US citizens for it to no longer be the US dollar?
ELI5: What is the world’s “reserve currency” and why would it benefit certain US citizens for it to no longer be the US dollar?
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Reserve currency is a currency that countries with unstable currencies keep in their central banks to create stability.
If the US dollar is no longer a reserve currency it becomes much more unstable. This will be very bad for Most Americans. But vulture capitalists thrive in instability. Especially if they are in close contacts with those in government.
Basically it allows them to speculate with far more knowledge (and funds) that the average US citizen, which will lead to a wealth transfer to the richest Americans.
This is especially true if the US government starts to use Cryptocurrency as a reserve currency, because these are very vulnerable to manipulation.
Countries need to do trade with each other, but using which currency? The world mostly uses the US dollar. When their banks loan out money and only need to keep some fraction of all the money they should have in cold hard cash, what currency would be the most stable? Generally the world decided the US dollar. Why? Everybody does trade with the US, and it keeps figuring out how to make payments on bonds (times when the US asks for a loan), so countries like holding onto US bonds.
That’s a lot of eggs in one basket. That’s a lot of pressure on our congress to just keep raising the debt limit each year. If the world diversified it’s portfolio of reserve currencies or just switched off the US dollar, then the US would have a huge shakeup for a long time (probably going through our worst recessions ever) but the world would be better off as their fate would be more in their own hands. In the end the US would do better participating in world trade rather than having everyone saying we’re too big to fail.
A reserve currency is one that other countries hold on to. By ‘hold’ I mean that they keep some reserve currency in the government’s bank. They do that because two reasons. First, when they trade with other countries they will use the reserve currency to pay for things, because it’s easier for both countries to use the reserve currency than each others.
Imagine Japan and Australia agree to a trade where Japan pays cash for a bunch of wool from Australia. If Australia receives Japanese Yen for the trade they can only spend that Yen where it’s accepted, and that’s Japan. But if Japan pays in a reserve currency, then Australia can use that money to trade elsewhere, or hold on to it themselves.
Which leads to the second and probably more significant reason; holding a reserve currency is a good, stable investment for other countries (‘stable’ means it’s not likely to change in value suddenly). That helps that country stabilize their own currency and economy.
Gold, basically. Its regarded precious practically everywhere.
Simply defined a “reserve” is an amount of money/liquidity banks hold to conduct day to day operations. When there is trade between two countries, it is usually convenient for banks to hold some amount of their reserves in the currency of other country. This is so that the traders can exchange local for that foreign currency to pay for the trade.
Over time, a country that exports more than they import accumulates reserves of foreign currency. Generally speaking a central bank or international bank doesn’t want to hold 200 different currencies as some of these currencies have volatile exchange rates etc ie it is risky. Hence they tend to exchange these foreign reserves into a few major currencies – generally from countries that are deemed major economies and are somewhat safe.
Since WW2, given US economic and productive dominance, many central banks of various countries hold a large part of their foreign reserves in US dollars or US bonds. This makes it easier for them to exchange funds etc since they hold a big sum of the same currency. This is what makes the USD the reserve currency.
One aspect to being a reserve currency is that all these other central banks don’t want the USD to drop in value since they hold a lot of USD. This forces the USD to be stronger than it probably should be given the large US deficit in trade. The makes imports to the US cheaper in USD terms and exports from the US more expensive in USD terms. This benefits US consumers by making foreign goods cheaper (and hold down domestic inflation). The downside is that this makes US exports more expensive and therefore less competitive.
One claim is that this has led to a lot of outsourcing and off shore manufacturing which has led to job losses especially among the lower skilled workers in the US. Hence there is an argument (not a strong one IMHO) that if the USD is less of a global reserve currency, then the USD will weaken and this will result in more factories opening up in the US benefitting more of the “working class”. This may also lead to higher inflation.
Safe to say that this is NOT something that can be explained or analyzed simply. Trying to make simple claims that “A leads to B” in the highly complex world of global supply chains, rapidly developing technology and very mobile capital is overly simplistic.