Maybe we should start with a quick reminder about the meaning of “a reserve currency”.

Well, a reserve currency could be defined as a foreign currency held by central banks and
other major financial institutions as a means to pay off international debt obligations,
commodities such as gold or oil, or just to influence their domestic exchange rate.
Considering this definition, there are many questions that rise automatically: do we really
need a reserve currency? Why the US dollar and not another currency? Could any other
currency replace the US dollar?
Do we really need a reserve currency? What is the point of having one?
What’s the point of having a reserve currency? From its meaning, it serves first of all as a
standard unit for international payments and thus it protects national currencies against
shock. But more importantly, manipulating reserve levels can enable a country’s central
bank to intervene against currency volatility and thus help to adjust exchange rate. If
demand for the yen drops, for example, Japan can use their extra US dollars to buy up the
unwanted yen, thereby propping up its value.
Why the US dollar and not another currency?
The first currency to be held in foreign reserves was the British pound, during the 18th
and 19th centuries. That changed after World War II, when the major economic powers
met at Breton Woods and established the exchange-rate system and the International
Monetary Fund to oversee it. Under that system, the US dollar became the “de facto
reserve currency”, partly because the United States was an economic power and partly
because the dollar was backed by gold (In other words, any country could trade its dollars
back in exchange for gold). As a result, the US dollar was considered extremely stable.
Nowadays, the dollar still makes up more than 50% of global reserves, trailed by the
euro, which constitutes about 25%.
Does any privilege accrue from being the reserve currency? Certainly. Part of the
privilege is that the US can borrow in its own currency and later pay back the debt in its
own currency even when the dollar has decreased in value. Furthermore, commodities
and international invoices are priced in the reserve currency (US dollar), so for the US
economy there is no additional cost in the event of currency fluctuations.
So, if there is a need for a reserve currency, and if the US dollar is the most stable
currency at the moment, why are China and Russia calling for a new global
currency?
It was reported recently that two of the world’s superpowers, Russia and China , have
called for a new global currency. I believe they’re doing this because they know that the
US is printing (or planning to print) huge amounts of dollars right now to pay down its
own massive debts (debts that other countries, like China, have been financing for years
by purchasing US Treasury Bonds).
But, what America tends to forget is that: “the more paper money you print, the less it’s
worth” and right now, with the Americans’ new stimulus plan, the federal reserve is
planning to print many more paper money. (Don’t forget this is the country of “yes we
can”).
So, how does it work?
You see, when a country buys a bond, in fact, it is loaning money and charging interest to
the issuer of that bond to be paid upon maturity.
Well, for years now, other countries have been buying US bonds so the USA could in
turn buy all of their made-overseas stuff. They were essentially loaning their biggest
customer the money it needed to buy from them. For instance, US owes China alone over
a trillion dollars. That’s just one of many countries that the United Stated owes money to.
So now, to get America ’s bills paid, The Federal Reserve is purchasing those US
Treasury bonds that other countries used to buy. To do that, a lot more dollars have to be
printed to buy them.
So, the fact that china is asking for a new reserve currency is a clear sign that China , as
the largest holder of US dollar financial assets (bonds), is concerned about the potential
inflationary risk of the US Federal Reserve printing money. Indeed, US dollars could
decrease in value very soon, because The US Federal Reserve would print many of them
to loan out. Logically, “the more there is of something, including money, the less it’s
worth”.
What is the Chinese argument with regards to the new reserve currency system? Well,
according to China , to better insulate countries from the ills of one country or one
currency, they are pressing the IMF to create a “reserve currency” based on shares in the
body held by its 185 member nations, known as special drawing rights (SDRs). The thing
is, at present, the currencies in the SDR basket are by weight, the US dollar (44%), the
Euro (34%), the Japanese Yen (11%) and the British Pound (11%). So ultimately, this
new reserve system would not make that much difference except that, in addition to the
US dollar, China would have the chance to diversify the basket of their reserves, keeping
the US dollar at the top (just like now). Their argument nevertheless does make sense.
Could any other currency or reserve currency system replace the US dollar?

Not so sure. Why? Because first of all there is always an advantage to an individual
central bank holding its reserves in the same currency as other central banks. By far, the
US dollar remains the main portion of central banks’ reserves around the world including
China (approximately, the US dollar would make up more than 50% of global reserves,
trailed by the Euro). Thus central banks find it attractive to hold US dollars because other
central banks hold US dollars. With everyone doing likewise, the market in dollars is
deep, liquid and likely to last for long time ahead. Secondly, oil and many commodities
are priced in dollars. Business deals around the world are done in dollars. Also, the US
dollar is still considered by most investors as the more stable currency compared to others
such as the Euro or the Yen. Finally, it would require acceptance from nations around the
world that have long used the US dollar and hold huge stockpiles of the US currency,
before shifting over to any other reserve system. Can this happen suddenly?
Let’s finish this paper by pointing out that the idea of creating a new global reserve
currency isn’t new. For decades there has been talk about creating an international
reserve currency and it has never really progressed. Why? Because managing such a
currency would require balancing the contradictory needs of countries with high and low
growth or with trade surpluses and deficits. Probably, in the end, the most powerful
currency will predominate. This would be the US dollar again considering its stability
and availability around the world.
Anyway, countries aren’t required to keep their reserves in dollars, they do it because
they want to (The dollar’s “primary reserve currency” status is more de facto than
official.) So, if China decided to dump its reserve of dollars, it would not only jeopardize
its relationship with the United States , but other countries wouldn’t necessarily do the
same.
So, Dear China, would you like to take the risk?
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