“Reserve” Currency: Criteria, Candidates and Consequences
India is not yet in a position to manage the consequences of converting the INR into a reserve currency.
Recent geopolitical events and the militarization of the financial system have highlighted the importance of geoeconomics, which is a form of power like geopolitical and military power. It can be defined as the use of economic instruments to promote geopolitical and national interests. These instruments can be trade, investment, policy (monetary/financial), aid, energy, commodities, cybersecurity, sanctions and sovereign wealth funds (SWF). This article examines the factors that could determine whether a currency can be a global reserve currency, the main candidates, and the implications.
A credible currency must be (a) stable (b) secure (c) store of value (d) medium of exchange (e) widely accepted and (f) trustworthy. Additional criteria for a global reserve currency are: (a) Characteristics and stability of the issuing country’s political system (structure, processes and institutions) (b) Quality of institutions and processes; (c) Size and prospects of the economy; (d) Integration of markets and the economy on a global scale; e) A transparent and open system able to withstand the impact of the “unholy trinity of macroeconomics”; (f) Credible legal system and rule of law; (g) Issuance quality of the sovereign; (h) Ability to bear the costs associated with issuing and operating a reserve currency, and (i) Size, depth and liquidity of markets.
Five major currencies are compared using these criteria, with an emphasis on the two main competitors, the US dollar and the euro. India is not yet in a position to manage the consequences of converting the INR into a reserve currency. The leading currency for a specific criterion is highlighted in green, and a strong negative factor is highlighted in red.
Cryptocurrencies do not meet several of the criteria due to the large fluctuations in their values against currencies. A South American country ran into serious difficulties because part of its reserves were held in cryptocurrencies that recently lost value. A currency being the 2nd area in which a State has a monopoly (organized violence within its borders is the first), States will not relinquish control of currencies. Central Bank Digital Currency (CBDC) is legal tender issued by a central bank in digital form and is a digital twin of paper-based fiat currency. Several countries are planning CBDCs that will be more efficient, less expensive, transparent and secure. The digital currency twins will face the same challenges in meeting the demands of a global reserve currency. A number of countries can eventually jointly design a digital currency for some mutual trade and even reserves. Such a common digital currency can compare its value to a combination of global currencies, including USD, without using USD and avoiding “touching” the United States in transactions, which has been cited as a reason. secondary penalties. Such cooperation will require high levels of mutual trust and transparency in addition to meeting the underlying financial and economic requirements. For example, BRICS bank may have a BRICS digital currency for member interactions, but India will be very uncomfortable if China has large holdings of a currency that can be used in India, and relations with Russia may now invite secondary sanctions.
SDRs and gold
Special Drawing Rights (SDRs) are a form of reserve currency issued by the IMF and their value is derived from a basket of currencies. Apart from the limitations due to the issuer itself, their quantity, distribution and allocation is a challenge, and their use as a reserve currency is limited. Gold can be the basis of a currency, but its supply is limited, its value must be calibrated and it will have limits in its very wide use as a medium of exchange. Gold-based digital currency backed by (sovereign) states can become a limited reserve currency.
The analysis integrating criteria and candidates shows that the US dollar followed by the euro will continue to dominate as reserve currencies. This position is an important catalyst for the use of several of the geoeconomic instruments mentioned above. These two currencies (&GBP) are also in the same geopolitical club and very often act in concert. The two main international economic organizations, the World Bank (USA) and the IMF (Europe) which were created in Bretton Woods in 1944 are controlled by the issuers of the same currencies. Infrastructure such as satellites and undersea cables, which are essential for the use of a digital currency, are also effectively controlled by them. Transaction monitoring through SWIFT is aligned with reserve currency dominance, and alternatives such as CIPS (China), SFMS (India), SPFS (Russia) and IndiaStack are too small and have their own implications. These are serious geoeconomic problems for other countries. The history of empires suggests that long-term geopolitical dominance is made possible more by good financial management than by military means
Asia has the largest population, the largest share of world trade, abundant resources, a combined economy larger than that of Europe, and powerful armies. China or perhaps Japan is Asia’s center of gravity, however, China worries others due to its coercive and transactional approach, and Japan does not have a fully independent foreign policy. Asia remains geopolitically very vulnerable due to its weak geoeconomic power, partly due to the dominance of reserve currencies by others. Economic growth by itself is not enough for geo-economic power, which will require coexistence and cooperation (not coercion), institutions and statesmanship in Asia.
Vivek Joshi is a consultant with A-Joshi Strategy Consultants Pvt Ltd and has over 25 years of international management experience.