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26 Oct 2022  (511 Views) 
International economy

Alternative reserve currencies
The US dollar has been the reserve currencies for the past decades. Many countries are now looking at ways to diversify their reserves, to avoid the risk of sanctions and confiscation by the US government. 

What are the alternatives?

The major currencies can be alternatives to the US dollar as a reserve currency. They include the Euro, RMB and Yen. 

How can these alternative currencies increase their share as a reserve currency?

What is the role of a reserve currency?

Each country keeps foreign currencies as a reserve currency to back up its local currency. It also uses the foreign currency to pay for its imports, especially for energy, food and manufactured products. 

For decades, the US dollar as been the favored reserve currency. Most international trade are denominated in US dollar. Many countries  keep their foreign currency holdings primarily in US dollars to pay for their international trade. 

They receive US dollars for their exports. If they have a surplus of US dollars, they can buy US treasuries to earn a return. The market for US treasuries is highly liquid.

The US dollar became the dominant currency for international trade due to the decision by Saudi Arabia, which was the largest exporter of crude oil, to receive payments in US dollars. The countries that need to import oil from Saudi Arabia have to keep US dollar as their reserve currency to pay for their oil imports. 

This practice of denominating oil in US dollars become the norm for the other oil exporting countries. 

How can this practice be changed?

Saudi Arabia may, in the near future, decide to accept a few currencies for its oil exports, e.g. USD, RMB and Euro. 

The oil importing countries may choose to pay for its oil in any of these currencies. If China pays in RMB, Saudi Arabia can keep the RMB to pay for its imports of products from China.

Saudi Arabia also needs to invest the excess RMB in China bonds to earn interest. If the bond market in RMB is developed and becomes liquid, this may be quite attractive to Saudi Arabia, or to other oil exporting countries. 

The oil exporting countries will still keep a large part of their foreign reserves in USD. However, this proportion will drop, as they diversify their reserves into other currencies. 

We will soon see a sharp decline in the role of the USD as the reserve currency of the world. 

When that happens, America will face a big problem in paying their huge debts. 

Tan Kin Lian


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