Download The Cost-benefit Analysis on International Reserve Currency Status

The Cost-benefit Analysis on International Reserve Currency Status: History
from historical and theoretical perspectives
Abstract: International reserve currency (IRC) is the highest form of currency
internationalization. Based on general cost-benefit analysis on IRC, this paper
explains the condition and influence to become a reserve currency from the
perspective of the correlation with trade balance, the capacity of external financing
and the autonomy of monetary policy respectively. In the final, we come to the
conclusion that the cost and benefit of the IRCs are closely related to the currency’s
international status. Classification exists in the structure of the international reserve
currency system, which are center and sub-center. The core of currency
internationalization is a natural selection process promoted by market forces. We also
realize that whoever overtakes shall have complete knowledge of and sufficient
patience in the currency internationalization
Key Words: International reserve currency, cost-benefit, trade balance, external
financing, autonomy of monetary policy
—1—
Chapter One: The General Cost-benefit Analysis on IRC
Section One: Basic Concept and the composition of IRC
I. Basic Concept
In a narrow sense, IRC refers to the currency used for the means of international
payment. In a boarder sense, it equals to the international currency. Generally,
currency internationalization is regarded as the evolvement of currency function from
trade valuation and settlement currency, investment and financing currency to reserve
currency. Therefore, IRC is considered as the highest form of currency
internationalization and the appearance of IRC greatly reduced the cost of economic
transactions in the world.
There only exists one currency in the ideal international currency system (ICS),
however, it is just an ideal assumption (Wang Huaqing, 2010). In different stages of
ICS, the category of reserve currency is somewhat different. In the gold standard
system, currency in each country contains legal gold content and the gold coin has
unlimited legal tender. Therefore, gold is a natural international reserves currency.
The earliest typical gold standard or gold coin standard was put into practice in the
UK. At that time, due to the status of the UK in the world economy system, London
became the global financial center, and then both Sterling and gold were used as
international reserve currency. In Bretton Woods System, US dollar pegged to gold
turned into the center of ICS, and became the major reserve currency. In Jamaica
System, the gold was demonetized, and IRC developed from monopolar pattern to
diversification. In the following, US Dollar，Deutche Mark, Franc, Yen, new emerging
Euro, and other fiduciary currencies are included in the IRC system.
II. Main components of IRCs
Since the establishment of Bretton Woods System，US dollar had become the center
of ICS. Even after this system collapsed, US dollar remained the main currency used
for international valuation, transaction and reserve. After the Euro emerged in the
—2—
world, depending on the comprehensive economic strength in Euro zone, the status of
Euro in the IRC system went up steadily, and it became the second largest
international reserve currency. The UK possessed a developed international financial
market with history, and with the traditional advantages in the international business,
Sterling still has a considerable influence. In addition, Yen, Australia Dollar, Swiss
Franc and other currencies also play important roles in the IRC system. According to
statistics made by International Monetary Fund (IMF), the total amount of
international reserve currency sharply rises to USD11.6 trillion at the end of 2014
from USD 1.8 trillion at the turn of the century which has been increased by 5.4 times
in the last fifteen years.
The countries “producing” reserve currencies are different from the countries
“consuming” reserve currencies. Most of the reserve currency in the world is held by
emerging market and developing country. Foreign exchange reserve held by emerging
markets and developing countries accounts for sixty percent of global foreign
exchange reserves and this percentage basically has not been changed since the
financial crisis in 2008. At the end of 2014, it reached 67%, increased by 32 points
than that just before the Asian financial crisis in 1996. Emerging markets and
developing countries holding so much foreign exchange reserve is the result of no
alternative choices in the current ICS, known as the “original sin”. Many developing
countries choose the export-oriented development pattern, as export and foreign direct
investment have a remarkable impact on national economy. Holding considerable
foreign exchange reserves not only is an inevitable result of accumulative trade
surplus, but also to meet up with the potential demand to stabilize exchange rate and
guarantee trade development (He Liping, 2008). Meanwhile, holding foreign
exchange reserves is also a financial crisis prevention tool. Most developing countries
experienced some period of foreign exchange shortage, and suffered from financial
crisis, therefore, for them, holding foreign exchange reserves means a form of self
insurance with defensive characteristics against speculative attacks from international
capital (Heller，1996). Observing the global financial tsunami in 2008, although
Russia, Korea and India and some other emerging markets experienced dramatic
—3—
exogenous shocks, large scale of capital outflow and sharp domestic currency
depreciation, the large accumulation of foreign exchange reserve indeed played a role
of “spare tire” to avoid financial crash and economic collapse (Guan Tao 2009).
Figure 1: The Increase of Global Foreign Exchange Reserve (Unit: Hundred
Million US Dollars)
140,000
亿美元
Hundred Million US
Dollars
120,000
Global Foreign
Exchange
Reserve
全球外汇储备
100,000
80,000
US
dollar reserve
美元储备
欧元储备
Euro
reserve
60,000
40,000
20,000
0
Data sources: IMF.
From above data, that main currency structure of IRC system is relatively stable. US
dollar and Euro are the main reserve currencies. Meanwhile, the feature of US dollar
being the single largest in the IRC system is obvious. At the end of 2014, the balance
of global foreign exchange reserve is USD11.6 trillion, and among which, the
composition of USD 6.1 trillion was disclosed with US dollar accounting for 62.9%,
Euro accounting for 22.2%, Yen, Sterling, Canadian Dollar, Australian Dollar and
Swiss Franc respectively accounting for 4.0%, 3.8%, 1.9%, 1.8%, 0.3%, and Other
currency in total accounting for 3.1%.
Figure 2: Main Currency Components in the International Reserve Currency
(Unit: %)
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100%
90%
Others
80%
70%
EUR
60%
AUD
50%
CAD
40%
CHF
30%
JPY
20%
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
USD
2001
0%
2000
GBP
1999
10%
Data sources: IMF.
From this figure, we realize that the status of US dollar reserve currency is declining.
The creation of Euro, a kind of super-sovereign currency, has been expected to
shoulder the same international responsibility as US dollar does. In practice, the role
of Euro on the IRC system is only second to US dollar. In addition, a tendency of “dedollarization” appeared from the recent international financial crisis. This ideology is
actively promoted by Russia and other emerging countries through trade settlement
and payment system which further makes the status of US dollar, Euro and other
reserve currencies decline. However, the powerful position of US dollar is difficult to
be affected in the short term and international monetary system headed by US dollar
shall not have disruptive change in the short period. Consequently, it is not pratical to
expect super fast speed on the reform of ICS. The diversification of IRC is a long
term process, and we may even say that there is no inevitable contradiction between
that and US dollar still being leading role. (Zhou Xiaochuan, 2009; Guan Tao, 2014).
Figure 3: Relative Decline of the Status on the US Dollar and Euro Reserve
Currency (Unit: Hundred Million US Dollars; %)
—5—
80.0
70,000
70.0
60,000
60.0
50,000
USD share %
40,000
合计（亿美元，右轴）
USD份额 %
50.0
40.0
EUR
share %
EUR份额
30,000
30.0
20,000
20.0
10,000
10.0
0.0
0
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
Data sources: IMF.
Section Two: The benefits of international reserve currency for the issuers
Different paths were taken to become main reserve currencies from historical view, as
their status is the consequence of “system design” of ICS, with the inner tendency of
self-reinforcement and to a great extent, it is also the result of market natural selection,
with the comprehensive reflection of various advantage of reserve currency issuing
countries. Reserve currency is able to bring some apparent and recognized benefits.
I. Seigniorage refers to direct and measurable returns from reserve currency.
In the context of fiduciary currency system, although Seigniorage has changed the
traditional connotation, its existence is widely proven. The idea that Seigniorage shall
be obtained by issuing countries of reserve currencies has been verified by Aliber
（1964）, Cohen（1971）, Bergsten（1975）, Tavlas（1997）. It is measured by Chen
Yulu.etc (2005) that from the establishment of Bretton Woods System to 2002, US
dollar seigniorage approximately accumulates to a trillion US dollars, which equals to
0.66% of the United States’ GDP. Seigniorage from Yen approximately equals 0.46%
of Japan’s GDP. As Quantitative Easing Policy is performed by many countries in the
financial crisis, countries such as the U.S. also acquires higher earnings from
—6—
Million
Hundred
US Dollars
Total of disclosure currency on the global
foreign exchange reserve (Hundred Million US
披露币种的全球外汇储备
Dollars, right axis)
Seigniorage.
II. Reserve currency is beneficial for the trade development of issuing country.
For the main reserve currency, when domestic enterprise is conducting their
international business, import and export is valued and settled by domestic currency.
In this case, the exchange fees and exchange rate risk shall be reduced. For example,
for US dollar, the accumulation returns accounts for about 1% of total volume of
import and export trade (Zhou Xiaochuan, 2009). Besides, reserve currency has a
great advantage for the adjustment of trade balance of issuing country. For
non-countries issuing reserve currency, when there arises disequilibrium of balance of
payments, especially when current account arises surplus or deficit, it needs foreign
exchange reserve to supplement. However, issuing countries of reserve currency are
able to make settlements by domestic currency and the deficit shall not result in
payment crisis. It is indicated by research that when ICS is dominated by single
sovereign currency, the total demands of IRC in the world is the total amount of
international payment deficit in the reserve currency countries. The issuing countries
of reserve currency can obtain financing of international payment deficit by issuing
currency. As a result, the adjustment cost will be imputed to other countries (Shi
Weiqi, 2014).
III. Reserve currency gives reserve countries the ability to borrow overseas
Reserve currency in overseas market shall be regarded as loan with no or low interest
obtained by the currency issuing authority (Neumann，1992；Zhang Yuyan, 2008),
which means borrowing overseas by using domestic currency. Moreover, in this way
issuing countries have no problem of currency mismatch, and instead, exchange rate
risk shall be imputed to the holder of reserve currency. Observed from the status of
US dollar reserve currency, it is found that the lower degree of the development of
one country's financial market, the more dependence on the USA financial assets and
financial market of this country, and the more closely trade connection of a country
with the USA, the more liabilities of the USA to this country, meaning the more dollar
asset held by this country (Forbes，2010).
One of the important reasons why US dollar has a sustainable power to borrow
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overseas is its developed financial market. Even during the period of subprime
mortgage crisis, American financial market condition is not completely deteriorated.
From the view of the freedom of the USA financial market, the opening degree of
capital market and the capacity of the capital market，the development degree of US
financial markets remains the leading one in the world (Mendoza，2009).
The restraint on US dollar to borrow overseas is a soft budget. The majority of
overseas borrowing of the USA does not require paying back with actual resources
and the returns obtained from US dollar exchange rate movement, currency inflation
and the USA foreign direct investment etc. will reduce the oversea debt. the USA
attracts the debtors all over the world due to this soft budget of borrowing capacity
(McKinnon，2001).
IV. Reserve currency is also beneficial for issuing countries to maintain the
status of international finance centre
Non-resident especially foreign official institutions hold international reserve
currency in the form of financial products, for example, governmental bond of reserve
currency country. It will stimulate the issuing country to give priority to develop
financial products and improve the convenience to make financial transactions. It is
also favorable to activate financial transactions, and enhance the country’s status of
being financial centre (Zhang Yuyan, 2008). However, some research also indicates
that this relationship is not necessarily that impressive (Zhou Xiaochuan).
V. Reserve currency also brings the advantage to obtain benefits beyond
economic field.
The benefits beyond economic field are demonstrated in obtaining currency power
(Peng
Xingyun,
2010),
improving
international
status
and
other
“soft
power”(Benjamin，2009). When sovereign currency becomes IRC, to some extent,
monetary authority shall serve as the central bank of the world economy, and its
liabilities shall act as standard of value and the final means of payment. The domestic
adjustment of interest rate and variation of currency supply shall become the
important factors to affect global monetary policies. Empirical evidence shows that in
financial crisis, there is no need to depend on other countries to obtain liquidity
—8—
support, such as Bank of England before World War II and Federal Reserve over half
a century.
Depending on the international monopoly of US dollar, the US frequently carries out
financial sanction to others which is also an important form to maintain and show the
power of US dollar (Xu Yisheng, Maxin, 2015)
Section Three: The costs of international reserve currency for the issuers
Every coin has two sides. Reserve currency also incurs certain costs, including the
cost brought by Triffin Dilemma, foreign interest payment, and factors that may lead
to internal imbalance(Benjamin，2009).
I. Triffin Dilemma is the fundamental contradiction between reserve currency
system and creation mechanism of international liquidity
US dollar serves as reserve currency on the basis of trade deficit of the USA.
However, large and continuous trade deficit shall result in losing confidence in the
dollar-gold standard (Yu Yongding, 2009). During the middle period of last century,
when the economy of Japan and Germany took off and export grew fast, US dollar
faced confidence crisis. As a result, US dollar’s peg with gold was broken and Bretton
Woods System collapsed. In the age of complete sovereign credit system, with no peg
with gold, Triffin Dilemma still exists for reserve currency. For example, the core
problem of a decreasing confidence in the US dollar has shifted to the one that the US
scale of external government debt has accumulated to the extend beyond its
diminishing fiscal capacity (Pan Yingli, 2014).
II.Issuing countries of reserve currency are confronted with the risk of sovereign
debt and the challenge for monetary policy autonomy.
In order to meet the world-wide demands for reserve currency, it is required that
countries of reserve currency should issue large amount of government bond. Even
with the low interest rate, the accumulative scale is still large. Meanwhile, the
sustainability of government debt can also be a problem as the sovereign debt crisis
repeatedly occurs in recently years.
For the close connection with the international market, issuers are easier to suffer
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reverse impact of economic risk from abroad, thus the domestic monetary policies are
more vulnerable to be hindered by external factors, and get the autonomy jeopardized.
According to “The Impossible Trinity”, under pegged exchange rate system, currency
internationalization may destroy central banks to control monetary base; in the
floating exchange rate system, currency internationalization may cause drastic
fluctuation of the exchange rate, and affect the effectiveness of domestic monetary
policy. Either in pegged exchange rate system or floating exchange rate system, the
liquidity of reserve currency, to a great extent, is determined by the preference of
non-resident currency holder. Thus it shall impair the effects of issuers’ policy. At the
same time, currency internationalization shall make the currency authorities hard to
monitor and manage money stock which will weaken the leverage of interest rate, and
cause the failure of interest rate transmission mechanism. In addition to this, currency
substitution arising from the development of offshore market and interest margin
between domestic currency and foreign currency shall also increase the difficulty for
issuers to regulate and control and the independence of currency policy gets
jeopardized.
III. Reserve currency may bring internal imbalance in the long term
When sovereign currency becomes international reserve currency, it is helpful to
improve external account, and reduce the external risk. However it may cause risk
accumulated domestically and exacerbate the disequilibrium of internal economy.
Trade deficit in the issuing countries of reserve currency is the source for foreign
exchange reserve in other countries. In the short term, it shall not bring much pressure,
but it is likely to establish accumulative contradiction. Such as, the widening gap of
trade imbalance, the tendency to decrease saving ratio, and the impaired policy
regulation. All of these phenomena have turned up in the USA. Furthermore, large
amount of US dollar return to the USA through channel of private sector investment
or the foreign exchange reserve. While this mechanism enables the USA capital
market to maintain low interest rates, some risks such as the real estate bubble and
financial bubble are brought up and unhealthy assets are generated (Yu Yongding,
2009). The key factor affects whether US dollar can keep its status of reserve currency
—10—
is whether there arises improper economic policy that will cause US dollar
depreciation and the USA inflation, which will reduce the appeal of US dollar as
reserve currency (Eichengreen，2005). The returns of reserve currency in the short
time may result in policy negligence in the long time. During medium and long term,
the issuers may face with the adjustment dilemma that is hard to get rid of, where the
disadvantages accumulated in the long run may be greater than the total benefits from
the short term.
Section Four: Research Arrangement in the following paper

Above-mentioned analysis about costs and benefits of status of being reserve
currency is decentralized in framework and not systematic in structure. In the
following part, we will inspect the empiricalperformance of different-leveled
reserve currency and the underlying reasons from the perspective of its relation
with trade balance, external financing and monetary policy from historical and
theoretical perspectives.
The following is described in 4 chapters: the second chapter analyzes whether trade
deficit is the precondition of turning into reserve currency from the perspective of
trade balance and if trade deficit will affect reserve currency to exert functions.
Meanwhile, the second chapter explores whether there exists necessary relation
between trade deficit and the status of reserve currency. The third chapter
concentrates on the difference in external financing for reserve currency in different
status and discusses the factors of determining overseas borrowing ability. The fourth
chapter discusses whether the status of reserve currency influences the autonomy of
monetary policy. On the basis of above analysis, the fifth chapter sums up the main
conclusions and inspirations, that is, the costs and benefits of being a reserve currency
are closely in association with the hierarchy of status of reserve currency.
—11—
Chapter Two: Reserve Currency and Trade Balance
Section One: Development of Trade Balance Concerning Issuing Country of
Reserve Currency
I. The Internationalization of worldwide main reserve currency in history started
with trade surplus
The functions of international currency fall into 3 types: one is acting as medium of
exchange, that is, international currency is privately used as payment currency during
trades and capital transactions and also used by authorities to intervene market and
balance international payments; the second function is to measure value, that is,
international currency serves as valuation currency among commodity and financial
transactions for private departments and also serves for authorities to confirm the par
exchange rate so as to act as anchor currency to peg exchange rate; the third function
is storage of value, that is, international currency is used for private departments to
choose financial assets and also held as international reserve by authorities in the form
of currency or high-liquidity assets.
There is a progressive relationship between the realizations of 3 functions concerning
international currency. Firstly, the internationalization of currency begins with the
frequent usage among international transactions, especially the international trades;
secondly, with the frequent usage and relatively stable currency value, non-resident
private departments and official institutions come into use this currency as valuation
currency; finally, because of the convenience of using this currency and stronger
acceptability, non-resident hold this currency as reserve currency with the purpose of
precautionary demand etc.
In general, the function acting as medium of exchange is the fundamental function of
international currency. The internationalization process of USD, Sterling, Deutsche
Mark and Yen started with trade surplus, as shown in Table 1.
Table 1: The Beginning of the Internationalization Concerning USD, Sterling,
Deutsche Mark and Yen
Issuing
Reserve
The beginning of the internationalization concerning
—12—
countries of
currency
reserve currency
reserve currency
From the outbreak of World War I in 1914 to the
outbreak of World War II in 1939, domestic and foreign
markets demands were greatly stimulated for American
products. The USA achieved the transformation from
the world's leading industrial power to the world's
largest economy and US dollar gradually became a
strong currency. From the end of World War II to the
the USA
USD
mid-late 1950s, the USA established General
Agreement on Tariffs and Trade (GATT), sharply
reduced the tariff and eliminated trade barrier, and
tackled discrimination among international trades in the
aim of largely outputting American products so as to
seize the international market.US dollar established its
dominant status in the international currency system
and finally turned into an international currency.
At the mid-late 17th century, The UK undergone
“financial revolution” and credit instruments, system of
government bonds and bank networks came into being
one after another. Meanwhile, British modern financial
system took into initial shape, Bank of Scotland started
to perform its functions as central bank. The following
first industrial evolution contributed to the rapid
The UK
Pound
development of British industries. The supply exceeds
the demand concerning domestic product, so The UK
pursued the free-trade policy and actively opened up
foreign markets and gradually turned into the world's
biggest exporter of industrial products. Furthermore,
the first industrial evolution further promoted the
development of financial industry in The UK. At the
—13—
last half of 18th century, London grew to be the world's
biggest financial centre. The bonds issued by British
government enjoyed much popularity throughout the
world. Thanks to the overseas trades, foreign
investments and colonial activities, Sterling was
continuously
outputted
and
witnessed
rapid
development in internationalization process.
Since 1950s, the former Federal Republic of Germany
enjoyed faster growth in economy and trades and
frequently obtained current account surplus which laid
foundation for relaxing capital control. From the
calculation of IMF, actual value of GDP of the former
Federal Republic of Germany in 1950 was equivalent
to 13.2% of the USA, which respectively rose to 20.8%
and 22.2% in 1960 and 1970. The proportion of
international trades of the former Federal Republic of
Germany in global trades rose from under 7% in 1955
to 10% in 1965. As early as the first half of 1950s,
Deutsche foreign trades of the former Federal Republic of
Germany
Mark
Germany appeared surplus which reached Deutsche
Mark 5.2 billion until 1960. With the settlement of the
problem involving foreign debts, the continuous
surplus of current account led to the growth of
international reserves, and the former Federal Republic
of Germany was capable of enabling Deutsche Mark to
be
exchangeable.
Deutsche
Mark’s
status
as
international currency had been enhanced after 1970s.
Thanks to the sustainable development in economy and
trades, current account experienced surplus for many
years. Foreign net debt of the former Federal Republic
of Germany was only second to Japan from 1986. In
—14—
addition, the improving on depth and extent of
domestic financial market and stable domestic currency
value of Deutsche Mark impelled the development of
Deutsche Mark internationalization.
Japanese international trades continued to grow and
remained a higher level after the swift postwar
economic recovery. From 1949 to 2004, Japanese
foreign trades rose from US dollars 1.42 billion to US
dollars 1019.7 billion, increasing by 718 times in 56
years, among which export trades and import trades
respectively increased by 1108 times and 502 times,
reaching US dollars 565 billion and US dollars 454.7
Japan
Yen
billion. Japanese growth rate of foreign trade was far
higher than the growth level of world trades over the
same term. From the usage in Japanese foreign trades,
with the continuous growth of Japanese foreign trades,
the proportion of Yen in Japanese foreign trades was
continuously improved. Yen began to be used in
national trades at 1960s and with the proportion of Yen
as pricing currency kept increasing from 1970 to 1980,
but it remained around 35% hereafter.
Data sources: Gao Cailin (2008); Yu Yongzhen (2013); Wang Xin (2009); Yu Jiang
(2008)
Above-mentioned currency internationalization were achieved by using their
comparative advantages to stimulate other countries’ demand for their domestic
commodities and for their currencies. The increasing demands and accumulation of
this currency improved the status of the currency in international financial market,
leading the internationalization of domestic currency to extend other functions.
II. Current situation: different conditions of trade balance concerning issuing
countries of reserve currency
To turn into reserve currency, it is expected to meet the needs of foreign residents for
—15—
domestic currency with the purpose of paying, storing value etc.. Furthermore, there
should be sustained and steady output channels for currency. The output channels for
currency fall into 3 types: the trade deficit of this country; capital outflow of this
country or the increasing of foreign credit; non-reimbursable assistance to others.
Trade deficit is the main output channels for currency, but recently, the trade balance
of issuing countries of reserve currency is different. As the main international reserve
currencies, the USA and The UK experienced perennial trade deficit, while Germany
(EU) undergone perennial trade surplus and Japan switched from surplus into deficit,
as shown in figure 4-7.
Figure 4: Balance of Payment between U.S. Cargo and Service Trade in 1960-2014
Hundred Million US Dollars
Year
Data source: CEIC.
Figure 5: Balance of Payment between British Cargo and Service Trade in 1955-2014
Million Pound
Year
Data source: CEIC.
Figure 6: German Balance of Payment of EU Cargo Trade in 1950-2014
—16—
Million Hundred Euro
Year
German
balance
Data source: CEIC.
trade
Payment Balance of EU Cargo
Trade
Figure 7: Japanese Trade Balance in 1978-2014
Billion Yen
Year
Data source: CEIC.
Section 2: Academic view of the Different Situations about Trade Balance of
Reserve Currency Issuing Countries and the Impact Analysis
I. Theory on trade balance of reserve currency issuing countries
Since 1960s, with the declined status of US dollar hegemony, the development of Yen
internationalization and the emerging Euro as regional cooperative currency, more and
more western scholars began to pay attention to the currency internationalization.
Most researches concentrated on the impact of internationalization on the economy of
issuing countries. Meanwhile, there are explorations on the relationship between
currency internationalization and trade balance, among which the most famous was
the “Triffin Dilemma” carried out by Robert Triffin, an American economist. In 1960,
—17—
in his book of the Crisis of Gold and U.S. Dollar – the Future of Free Exchange,
Triffin put forward that the USA supplied international liquidity for other countries
through chronic trade deficit, which was a paradox with the requirements of chronic
trade surplus aiming to maintain international reputation of US dollar. The inner
contradiction was called “Triffin Dilemma”.
Despite that many scholars held that the internationalization of domestic currency was
favorable to the development of international trades, opinions vary on whether the
internationalization of domestic currency will bring up balance of payment deficit.
The affirmative side supposed that international seigniorage was obtained on the basis
of international payment deficit. Therefore, if the issuing country of international
currency is to enjoy the returns on seigniorage, it is expected to keep its international
payment deficit. When there occurred deficit in current accounts, the issuing country
can gain the returns on seigniorage under current accounts. While capital accounts
deficit occurred, the issuing country can gain the returns on seigniorage under capital
accounts (Cohen, 1971). With the development of internationalization, the demands of
foreign residents for assets of domestic currency will be strongly increased, which
will contribute to the appreciation of domestic currency. Consequently, the issuers’
competitiveness of exports declined so as to influence the scale export trades (Frankel,
1991).
The opposing side held that the issuing country of international currency can obtain
financing for international payment deficit through issuing currency. The increasing
issuance of currency depreciated domestic currency and then effectively stimulated
exports (Aliber, 1964). The international usage of currency can improve the trading
conditions of currency-issuing countries. That is, when a currency was widely used,
the value of commodity purchased by measure value will rise, significantly improving
the trading conditions of exporting country (Prakash, 2006).
In conclusion, the direct influence of currency internationalization on trade balance
presents to be positive and negative. There is no certain cause-effect relation between
the status of reserve currency and balance of payment deficit.
II. Impact analysis on trade balance of reserve currency issuing countries
—18—
The international usage of one currency must satisfy two basic requirements. The first
one is the confidence possessed by non-residents on value of currency, which relies on
the stable internal value of currency, namely, low inflation. From the prospective of
the function acting as medium of exchange, non-residents hold currency mainly to
pay for international transactions. Only when the low inflation is ensured, the
domestic purchasing power of currency can be guaranteed. According to the theory of
purchasing power parity, compared with the currency with high inflation, the currency
with low inflation faces with appreciation pressure, so the low inflation also ensure
the external purchasing power of international currency. The second is the degree of
development and openness of this country’s financial market. Closing the financial
market, for example, restrictions on currency exchange shall increase the costs of
currency transactions. If the liquidity of currency is limited, the usage of international
currency shall be hindered. Prosperous financial market possesses numerous financial
instruments and sound secondary financial markets which help to decrease the
transaction costs and improve the liquidity and profitability of currency. The opening
of financial market and the booming of offshore financial business promote the
international usage of currency.
The countries with smaller economic scale or high degree of external dependence are
more likely to suffer from “Triffin Dilemma” and their currencies are more difficult to
turn into reserve currency. The reserve currency issuing country supplies international
liquidity for other countries through chronic trade deficit, capital output, foreign aid
and other methods. Generally speaking, trade deficit will sap the confidence
possessed by non-residents on value of currency and thus put pressure on exchange
rate. Although the confidence is influenced by exchange rate, it mainly depends on
the changing of internal value of currency. Domestic price level in one country does
not solely rely on import and export, but also lie on domestic consumption,
investment, currency supply and other factors. When the countries with smaller
economic scale or higher degree of external dependence output currency through
trade deficit and capital outflow, it is difficult to guarantee the stability of domestic
economy and finance. Therefore, those economies are more likely to face with
—19—
“Triffin Dilemma”. While the countries with larger economic scale are more
independent and therefore more tolerate to “Triffin Dilemma”.
III. Quantitative analysis on trade balance of reserve currency issuing countries
In order to study whether there exists necessary relation between IRC and trade
balance, with the year-over-year changes of trade balance concerning the USA, EU,
Japan, the UK in 1999-2014 as horizontal axis and the proportion changes of currency
in official foreign exchange reserve in 1999-2014 as vertical axis, as shown in Figure
8, it is discovered that there is no obvious correlation between them, which proves the
status of reserve currency shows no distinct influence on the trade balance.
Figure 8: Relations between Trade Balance and Status of Reserve Currency
Note: horizontal axis is the year-over-year changes of trade balance; vertical axis is
the proportion changes of contra currency in official foreign exchange reserve
Section Three: Brief Summary
Medium of exchange is the fundamental function of international currency.
Throughout the internationalization process of main reserve currencies in the global,
all of them initially started with trade surplus. Issuing countries stimulate other
countries’ demand for domestic commodities and then increase foreign residents’
demands for domestic currency through the comparative advantages. The increasing
demands and accumulation of one currency improve the status of the currency in
international financial market, resulting in the internationalization of domestic
—20—
currency.
“Current account deficit, capital account surplus” is an approach to output domestic
currency. When the internationalization of domestic currency enters into a higher
level of being reserve currency, the assets of domestic currency held by non-residents
will increase. Therefore, the internationalization of domestic currency will boost
rather than reduce pressure of capital inflow. Before the outbreak of the international
financial crisis in 2008, the USA provided world with US dollars through purchasing
other countries’ commodity. Meanwhile, the USA issued financial assets such as US
dollars bonds to realize capital inflow. Therefore, the USA achieved the balance of
international payment in a manner of “Current account deficit, capital account
surplus”. The double circulation system in international economy was once thought to
be “The New Bretton Woods System”. Some economists consider “The New Bretton
Woods System” can solve Triffin Dilemma; moreover, it is sustainable and living.
The countries with smaller economic scale or higher degree of external dependence
are more likely to be subject to “Triffin Dilemma” and would face with more
difficulties to turn into reserve currency. If currency serves as main international
reserve currency like US dollars, the structure of international balance of payment of
“Current account deficit, capital account surplus” may be one choice. However, the
data analysis from both the different directions trade balance and the non-correlation
between trade balance and status of reserve currency fail to prove the uniqueness of
the above choice. It is worth noting that it is difficult for the countries with smaller
economic scale to guarantee the stability of domestic economy and finance. For those
economies, they output currency through trade deficit and capital outflow during the
internationalization of domestic currency, while more independent countries with
larger economic scale are more tolerate to “Triffin Dilemma”.
The balance of payment and the internationalization of domestic currency are two
completely different issues, so it is improper to simply put the blame on the
internationalization of domestic currency if international balance of payment is
unbalanced. The balance of payment is a reflection of internal balance in external
departments. For instance, current account surplus results from more savings than
—21—
investment with insufficient effective domestic demand; capital account surplus may
result from underdeveloped financial markets and excessive dependent on foreign
capital. There is no inevitable connection between
the trade balances and the
currency used in pricing and settlement during foreign trades. Just as the following
cases, the domestic currencies being main international currencies, Japan experiences
long-term current account surplus while the USA undergoes long-term current
account deficit; with Euro as the common currency in Eurozone, Germany
experiences long-term current account surplus while Spain, Portugal, Italy, Greece,
Ireland and other countries undergo long-term current account deficit. Therefore, the
strategy of using the internationalization of domestic currency to solve unbalanced
international balance of payment and the accumulation of foreign currency reserve is
counterproductive and futile. Conversely, the practice of simply blaming the the
internationalization of domestic currency for unbalanced international balance of
payment is ineffective and meaningless.
—22—
Chapter Three: Reserve Currency and External Financing Ability
Section One: the overall Performance of Overseas Borrowing
Currency is with purchase power to obtain social wealth. It is debt currency in nature
under the sovereign credit system and is the liability of currency authorities to all
holders of currency. As international circulating currency, reserve currency is the
liability to all holders of currency. Liability is the typical characteristic of modern
financial operation which not only reflect in individual micro-level such as
commercial bank but also in macro-level and global vision such as international
reserve currency. In addition, liabilities-bearing ability is a vital component of the
benefits of reserve currency.
The main developed economies and other issuing countries of reserve currency
borrow overseas with domestic currency, with no risk of currency mismatch and no
restriction of international liquidity. Therefore, they enjoy the obvious unilateral
returns. However, the accumulation of reserve assets in developing countries is
achieved through offering cheap funds to the issuing countries of reserve currency
whcich means holders undertake the investment risk while supplying funds. Since the
assets are priced in the form of foreign currency, besides the disadavantage of rather
low investment returns (low interest rates of United States government bond and
negative rates of national debts in Euro zone), once the reserve currency is
depreciated, foreign exchange reserve of holders will suffer from significant financial
losses in denomination value. “Original sin of small countries” put forward by
Mackinnon, an American economist, profoundly reveals the only helplessness of
using non domestic currency as reserve currency. From this perspective, reserve
currency can also bring returns from overseas borrowing.
I. The borrowing performance of reserve currency from net international
investment position (NIIP)
For reserve currencies of different levels, the capacity and performance of overseas
borrowing differ greatly. International investment position provides us with a reliable
instrument to inspect the financial assets and liabilities stock assumed by one country
or region in specific time-point to other countries or regions in the world. The
—23—
international investment position can measure the condition of foreign assets or
external liability concerning the reserve currency issuing countries. The US dollar has
powerful capacity to borrow overseas continuously. By analyzing the data of the USA
international investment position, it can be discovered that the USA international
investment remained net negative position since 1986. Moreover, net negative
position was continuously enlarged, surging from US dollars 27.8 billion in 1986 to
US dollars 1.8 trillion in 2007. After the subprime mortgage crisis, net negative
position was further enlarged and it reached to US dollars 4.6 trillion in 2013.
Therefore, development process of the USA overseas borrowing can be generally
understood from those data.
Figure 9: the USA Net International Investment Position
1.0
0.0
(1.0)
(2.0)
(3.0)
(4.0)
2012年
2010年
2008年
2006年
2004年
2002年
2000年
1998年
1996年
1994年
1992年
US
1990年
1988年
1984年
1982年
1980年
1978年
1976年
Dollars)
1986年
THE USA (Trillion
美国（万亿美元）
(5.0)
Data source: Wind.
As one of the world largest international reserve currencies, the ability of Euro to
borrow overseas is strong. The international investment in Eurozone kept negative
position since the establishment of Eurozone. The negative position in Eurozone was
continuously enlarged around the eruption of American subprime mortgage crisis in
2008, from Euros 0.4 trillion at the start of this century to Euros 1.5 trillion in 2008.
This indicated the improved overall level of external liabilities in Eurozone. During
—24—
the short term from the outbreak of subprime mortgage crisis to the outbreak of
European debt crisis, international investment negative position in Eurozone was
sharply enlarged to Euros 2.4 trillion. The overall liabilities level in Eurozone kept
shrinking after the second quarter of 2009, which shrank to Euros 1.5 trillion in 2013.
The scale is far from the USD net international investment negative position of US
dollars 4.6 trillion the same term.
Figure 10: Net International Investment Position in Eurozone
0.0
(0.5)
(1.0)
(1.5)
(2.0)
Eurozone (Trillion Euros)
欧元区（万亿欧元）
(2.5)
Data sources: Wind.
Yen is steadily in the third or fourth position in the international reserve currency
system for a long time, however, compared with US dollar and Euro, the performance
of oversea borrowing for Yen is not impressive. Japan does not appear as a large
debtor, instead, it always stands as the biggest creditor for more than twenty years in
the international financial market. NIIP always keeps greatly positive and the scale
extends from JPY 133 trillion in 2000 to JPY 325 trillion in 2013.
II. Borrowing performance of the reserve currency from the view of the bond
outstandingk in the international bond market
From the view of the international bond market, it also shows differences among the
borrowing power of the reserve currency in different levels.
The comparison of stock scales for US dollar bond, Euro bond, and Yen bond in the
international bond market can reflect the different levels about the borrowing ability
—25—
of the three reserve currencies. In the international bond market with the stock up to
the USA 22 trillion (by the end of 2013), the stock of US dollar bond is 7.8 trillion,
Euro stock 9.9 trillion and Yen stock about 480 billion. Over the past twenty years, the
stock of US dollar bond is always kept accounting for 30%-50%, Euro stock
40%-50%, and Yen bond stock rose temporarily in the early 90s and then dropped
continuously from 17% to 2% in 2013.
Figure 11: Stock in International Market
25,000
billion
USD One
十亿美元
20,000
15,000
Total issues
Euro
US dollar
Yen
10,000
5,000
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
0
Data sources: BIS.
Section Two: Structural Analysis of Borrowing Oversea in Reserve Currency
I. Concrete analysis of US dollar external liabilities
i. Quantity and Price analysis of US dollar external liabilities
1. From the view of “quantity”: asymmetry between US dollar external liabilities and
foreign investment
There are big differences between the foreign investment and US dollar borrowing
oversea, i.e., it is obviously asymmetrical between the USA foreign investment and
investment in the USA from other countries. The USA foreign investment mainly
refers to securities investment and direct investment with long term and high yeild.
From analysis of the cross-section data of the USA international investment in 2013, it
shows that overseas assets of the USA mainly include foreign investment from private
—26—
sectors accounting for 85% of the USA overseas assets. The foreign securities
investment of private sectors especially the stocks investment accounts for 30% of the
USA overseas assets, and its direct investment for 24%, while the investment in the
USA from other countries mainly refers to the highly liquid bond investment. In the
investment in the USA from foreign private departments, 50% is for US bonds, and
the investment from the public departments is even more concentrated with 76% for
United States government bond. The above conclusion can also be obtained by the
analysis of the USA international investment data in other years, which shows the
unique national capital structure with “short-term borrowing plus long-term
investment”
Figure 12: Overseas Assets of the USA
2%
公共部门资产
Assets of private departments
13%
24%
Assets of private departments:
私人部门资产：直接
direct investment
投资
Assets
of private departments:
私人部门资产：证券
bond
投资investment
21%
Assets
of private departments:
私人部门资产：其他
other
creditor's
rights
债权
Others
其他
40%
Data sources: Wind. (Note: 2003 annual data)
Figure 13: Assets in the USA of Foreign Countries
18%
23%
美国政府债券
United
States government bonds
其他债券及债权
Other
bonds and creditor’s rights
12%
直接投资
Direct
investment
其他
Others
47%
Data sources: Wind. (Note: 2003 annual data)
—27—
2. From the view of “price”: there are visible differences between the returns of
foreign investment and costs of the external liabilities in the USA
The cost of the USA external liabilities is far less than the benefit of the USA foreign
investment. From the data in 2001-2006, the return rate of the USA oversea assets
matained at above 4%, but assets in the USA of the foreign countries only 3%, and the
difference is from “valuation effects”. The difference is also great on the investment
scale. Taking the direct investment for an example, the scale of the overseas direct
investment from the USA is USD 6.3 trillion which is 30% more than the direct
investment in the USA from foreign countries with USD 4.9 trillion. The
superposition of differences of the scale and returns rate further enlarges “valuation
effects”. Therefore, even though the USA is a net debtor country, it also can obtain the
positive benefits from borrowing overseas.
The uniqueness of the national capital structure and assets valuation in the USA forms
the USA “exorbitant privileges”. With the unique advantage of the USA dollar being
international reserve currency and transaction currency to borrow overseas, the USA
avoided the currency mismatch risk and reduced the scale of external liabilities to
achieve “American default” by “valuation effects”; the capital structure led by debt
financing and the investment structure led by overseas direct investment realize the
reasonable match of high returns investment and low costs liabilities to gain net
returns. As a result, it plays a positive role in improving sustainability of the USA
asset-liability structure to decrease relevant risks and maintain financing ability of the
USA.
ii. US dollar overseas borrowing from the view of United States government bond
US government bond with the most liquidity and security is the important carrier of
US dollar borrowing overseas and also a key element in US dollar debt system. For
the raising amount, the annual circulation of United States government bond, from
USD 600 billion of the annual value in the middle 90s of the past century to more
than USD 1 trillion in 2008, and further up to above USD 2 trillion since the subprime
mortgage crisis (2009-2013), accounting for one third of the total annual circulation in
the USA bond market at present. For the stock, the annual stock of United States
—28—
government bond, from USD 3.4 trillion in the middle 1990s of the past century up to
USD 5.8 trillion in 2008 and obvious enlarged to above USD 11 trillion in 2013 after
the subprime mortgage crisis, also accounting for thirty percent of the total stock in
the USA bond market at present
The holder-structure and scale changes of United States government bond may
provide a view of ability to borrow overseas in US dollar. The data from U.S.
Department of the Treasury are showing that United States government bond of
foreign investors in 2007 was USD 2.2 trillion, accounting for 22.5% of various US
equity bonds held by foreigners And USD 5.6 trillion up to 38.8% until 2013. Forty
percent of assets of the USA of external investors are United States government bond.
The investor structure of United States government bond also means that half stock of
United States government bond with USD 11 trillion in 2013 was held by external
investors. In another words, half of the borrowing of U.S. Treasury Department is
held by foreign countries.
Figure 14: Proportion of United States Government Bond and US Bond Held by
Foreign Investors
60%
50%
40%
United
States
国债
government bond
30%
各类债券
Various
bonds
20%
10%
0%
Data sources: Wind.
The increment change also shows the unique status of overseas borrowing in United
States government bond market. The assets increment of foreign countries in US
public sectors was 283.744 billion US dollar in 2013, 83% of which may reflect the
—29—
increasing amount of United States government bond. During the years of 2000-2013,
71% of assets increment of foreign countries in US public department was from
United States government bond. Broadening liabilities forms from United States
government bond to all kinds of bonds, the ability to borrow overseas for United
States would stand out similarly. Various liabilities of the USA to foreign official
institutions was up to USD 58.8 trillion in 2013, increased by more than one time of
USD 2.8 trillion in 2006, while above 60% of liabilities was United States
government bond with high liquidity.
II. Structural analysis of Euro overseas borrowing
The ability to borrow overseas in Euro is not weak. The proportion of Eurozone
government debt held by the non-residents in GDP increased significantly from 16%
in 1995 up to 45% in 2013 in absolute amount. The relative proportion went up from
22% in 1995 up to 53% in 2009 and decreased slightly after European debt crisis,
which also shoed that the ability to borrow overseas for Eurozone countries had been
improved greatly in the past twenty years.
Figure 15: Proportion of Eurozone Government Debt Held by the Non-residents
60
非居民持有的政府债务（%
of GDP）
Government debt held by the non-residents
(% of GDP)
50
非居民持有比例（%）
Proportion held by the non-residents (%)
40
30
20
10
0
Data sources: ECB.
However, overseas borrowing for Eurozone countries does not mean to be held by the
countries outside the Eurozone. Eurozone is just a currency union but not a fiscal or
political union. In Eurozone, the currency is consolidated while debt of each country
is independent. To a great extent, Eurozone debt displays characteristics of
internalization. For instance, most of Greek debt is held by other countries inside
—30—
Eurozone, especially commercial banks from Germany and France holding creditor's
rights with large share. With the data from Business Week, banks from Germany hold
about 250 billion of national debts from countries caught in the debt dilemmas in
Eurozone.
The differences of holdings in the government debt by non-residents are great in
Eurozone countries. For example, half of the government debt, in these countries such
as Germany, France and so on, is held by non-residents, whiles, in Italy, Spain, etc,
the government debt is possessed mostly by residents.
Figure 16: The Holder-structure of the Government Debt from Eurozone Countries
Eurostat。Diagram sources: Eurostat.
III. the ability to borrow overseas in Yen is not impressive
Yen as the reserve currency is in steady status, which does not match completely
with the performance to borrow overseas. The data from Ministry of Finance of
Japan are showing that, by the end of 2013, total amount of net creditor's rights from
Japan overseas assets was JPY 325 trillion, 80% (262 JPY trillion) of which was the
net creditor's rights from private sectors and only 20% (JPY 63 trillion) from public
sectors. So far, Japan has been continuously the biggest creditor country for 23 years.
In the corresponding period, total amount of Japan overseas assets is JPY 797 trillion,
or about USD 7.8 trillion, which means that JPY 472 trillion of borrowing overseas
is just equal to 60% of overseas assets. In overseas debts of Japan, about half is in
the field of securities investment, and a quarter in the credit and loan. The
performance of Yen as one of the international currency to borrow overseas is not
—31—
impressive.
Figure 17: Investments Abroad and External Liabilities of Japan
900
对外投资 abroad
Investments
对外负债liabilities
Exterior
对外净债权
Overseas
net creditor's rights
800
700
JPY trillion
万亿日元
trillion
600
500
400
300
200
100
2012
2010
2008
2006
2004
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
1980
1978
1976
1974
1972
0
Data sources: Ministry of Finance Japan.
Section Three: Reasons for Reserve Currency with different external
financing performance
I. The circulation system of US dollar external debts from the view of history
The ability of US to borrow overseas is beyond other reserve currencies. US dollar
debt financing with short-term and low returns may support the foreign direct
investment with long-term and high returns outside the USA. The dependence of US
dollar reserve currency by public departments and private departments in each
country is not yet replacable (Eswar, 2014). Except realistic perspective of the distinct
capital structure of national debts, the circulation system of US dollar debt is formed
historically to help understand the unique of ability to borrow overseas for US dollar
reserve currency.
After Bretton Woods system collapsed, United States government bond became a kind
of investment generally accepted by international society and carrier of repatriation
for overseas as a substitution of gold. In fact, US dollar assets in foreign central banks
exceeded the gold reserve of U.S. Treasury Department in the mid-late 60s of the past
century (Fu Zheng, 2013). The USA forms the virtual US dollar debt standard after
the gold standard. From the path of historical evolution, US dollar borrowing overseas
—32—
experienced
two
important
stages,
petroleum
exporting
countries
and
export-depended countries in East Asia separately brought into the circulation system
of US dollar debt which is significant expressions for US dollar to consolidate its
status as the reserve currency.
Petroleum exporting countries are the main object for US dollar overseas borrowing,
and the process is called recycling of petrodollars. Generally, with the dominance of
global politics and economics, the USA made US dollar become the most important
international reserve and settlement currency after the war. The international
petroleum is priced in US dollar in petroleum trade domain, and it occupies the
monopoly status in the settlement currency of petroleum trading, with almost 100% of
international petroleum transaction in US dollar. The current account, for petroleum
exporting countries in the gulf countries, always is in surpluses. While their native
financial market is underdeveloped, the trading surpluses is used for investments
abroad in the form of sovereign wealth fund. However, the USA has the powerful
economic strength and developed capital market, so the USA market provides highly
developed and rapid liquidity investment in petrodollars for energy exporting
countries, which makes the petrodollars flow back to the national debt and deposit to
supplement the trade and financial deficit and to support the economic development.
In the end, most portion of the trade surplus in petroleum exporting countries forms
the external liabilities by the USA government to these countries, which makes these
countries become part of the USA debt circulation. Most petroleum importing
countries need to use the trade surplus in exchange of US dollar and exchange
reserves for external payments, so in fact they also cannot escape from the USA debt
circulation. However, the USA can use the banknote printing machine to produce
massive US dollars and purchase cheap goods and services in the world.
Following the economic growth of East Asia and emerging economies especially fast
growing export in these regions, the USA debt circulation also include these regions.
On the one hand, the USA procures large numbers of consumer goods from Asian
country so that it causes US dollar exchange in some countries such as China and
Japan to increase rapidly, and at the same time, the US trade deficits are extended
—33—
continuously but called “deficits without tears”. On the other hand, the USA issues a
lot of bonds and these countries such as China and Japan purchase large sum of US
dollar assets, which causes US dollar flows back to the USA to supplement the gap of
its trade deficit. Such circulation system of US dollar makes the USA not to worry
about the pressure from the international payment deficit to domestic economy, and
subscription of United States government bond by foreign countries provides
conditions for the expansionary currency and fiscal policy. At the same time of
maintaining the existing recycling of petrodollars, emerging industrial countries and
export-oriented countries in East Asia further intensify the mode of the USA debt
circulation worldwide so as to reinforce and enlarge the ability of US dollar reserve
currency to borrow overseas.
The cost of US dollar external liabilities is relatively controllable. Most external
liabilities in the USA is priced in US dollar to avoid the risk of currency mismatch.
As the unique standard currency, US dollar enjoys the hegemonic status in
international currency system, possessing abilities of near-limitless financing and
creating credit, and adjusting the exchange rate to change freely the cost of external
liabilities. Contingency measures of creditor country are limited actually in current
and a long period in future for the closely interdependent relationships between
creditor countries and the USA in economy and spillover effect caused by adjusting
macro-policy in the USA. Moreover, the advantage position in IFC and superiority
in establishment of the international finance rules and standards are helpful to defuse
the risk of external debt. The USA possesses the ability to transfer liability risk by
market and policy forces. In addition, returns rate of investments abroad is always
higher than the interest rate of external liabilities which also is important economic
explanation to support US dollar external liabilities. Pessimistic expectation was
made by many studies on sustainability of the USA external liabilities previously,
but it is not proved by reality.
II. The Internal Imbalance in Eurozone Restricts the Ability of Euro Reserve
Currency to Borrowing Overseas
The structural imbalance restricts the ability of Euro reserve currency to borrowing
—34—
overseas. The proportion of overall government debt in GDP in Eurozone countries
was 91% in 2013, which was not the highest in developed countries for in Japan it
exceeded 200%. But the government debt of Eurozone varies greatly among countries
in this area. The portion of government debts in GDP in the core countries such as
Germany and France is almost below 80%, while in the relatively marginal countries
such as Greek, Portugal, Italy, Ireland, and so on above 123%.
Defects of mechanism in Eurozone make costs of debts in Eurozone countries to
diverge from national credit ratings for a long period. Eurozone countries deliver
currency sovereignty to European central banks, but retain the fiscal sovereignty
separately. Credit rating, issuance amount, and mobility are lower when each member
country issues national debt separately than that when these countries unify to issue
the national debt, so when the national debt of the country (such as Greek) with poor
financial situation goes wrong which may cause the systematic crisis for whole
Eurozone. At the beginning of establishment of Eurozone, the principle of
non-common sharing which equals non-salvation provision, was written into Treaties
of the European Union which specified that member countries in this area must be
separately responsible for the issuing liabilities and forbid strictly EU or any member
countries to undertake the liabilities issued by another member country. Non-salvation
provision is designed to emphasize that each member country must bear its debts
separately by setting rules in advance, urge that the markets make a difference among
the sovereign debts of each member country, and give different pricings in accordance
with various risk features. The ultimate purpose of the design is to avoid the moral
hazard and prompt member countries to abide by financial discipline (Yu Yongding,
2010). However, in practice, the markets failed to make a valid distinction and give
different pricings. With common currency and unified benchmark interest rate, the
currency mechanism in Eurozone means that member countries can use the unified
credit rating to borrow Euros. The deficit incurred in intra-regional trade of peripheral
countries, without needs of support from foreign exchange reserve, can obtain directly
convenience of Euro financing by the mechanism arrangement of Target II in
Eurozone and make public and private debt financing in this country by the interest
—35—
rates in these countries with high credit. Under the common currency mechanism in
Eurozone, the cost of borrowing overseas will be astringed to the core countries such
as Germany and so on for a long time. The studies show that, since the establishment
of Eurozone in 1999, the rate of the sovereign debt financing has generated obvious
convergence in each member country. For example, 10-year Treasury yield in
Germany and Greek is 5.14% and 6.30% respectively with only 1.2 percent of interest
margin in 1999, and almost the same in 2003. A rapid expansion appeared when
Greek debt crisis broke out, and the gap was enlarged to a stunning 21 percent in 2012.
The returns and costs of marginalized countries such as Greek in Currency Union
reflect the conflict between free-rider and self-restriction of these countries. The low
financing cost produced the trend of the long term debt at a large scale losing market
constraints in these countries (Flessbeck, 2011), resulting in European sovereign debt
crisis. Euro as the second largest reserve currency in the world does not help them a
lot, therefore, these countries in southern Europe crisis have to make painful fiscal
consolidation and structural adjustment, and bring the punitive rate rather than the
zero rate into market financing.
Fgure 18: Comparison of 10-year Treasury Yield in Germany and Greek
%
25
25
20
20
15
15
10
10
德国
Germany
希腊
Greek
Jan-14
Jan-13
Jan-12
Jan-11
Jan-10
Jan-09
Jan-08
Jan-07
Jan-06
Jan-05
Jan-04
Jan-03
Jan-02
0
Jan-01
0
Jan-00
5
Jan-99
5
利差（右轴）
Interest
margin (right axle)
Data sources: CEIC.
There is huge difference between economic level and financial situation in Euro
countries, thus it is also very different for sovereign credit rating, the returns rate and
the risk level of the national debt in each country. The above case shows that it is
difficult for Eurozone countries to form the national debt with high credit rating and
—36—
high liquidity equal to United States government bond, etc. The national debt is a
basic form of value reserve, and Euro as a reserve currency falls down in the
competition with US dollar. European debt crisis may unlikely cause Euro to collapse,
but it is inevitable for the status of Euro currency reserve to suffer the negative impact.
In the global reserve currency system, the stock of Euro reserve currency was
historically up to 46% of US reserve currency in the third quarter of 2009, however,
the proportion obviously decreased after European debt crisis, and dropped by 10
percent in the third quarter of 2014.
III. Yen’s reserve currency to borrow has the internal characteristic
Japan once promoted the internationalization process of domestic currency positively,
and Yen gradually ascends the position of reserve currency and stays in the top five
stably. But, Yen does not show the ability as US dollar obtaining cheap financing
ability on a global scale.
The important reason of Yen’s weak ability to borrow oversea is the relative closed
and conservative financial markets. The long-term low profit policy makes its
domestic financial markets have limited attractions. Financial markets in Japan have
many limitations for foreign investors, and it is not convenient as European and
American markets. At the same time, Yen’s overseas stock is not high, and external
debt in Japan is low. Japanese financial markets especially national bond markets
show high internalization. Government debt balance of Japan breaks through 1,000
trillion Yen at the end of June 2013, but the debt structure is different from that of
European crisis countries. A lot of debts are digested in domestic and self-sustained
rate is high. Most of the national debts in Japan are held by domestic organizations
and individuals, and it is not easy to be influenced by external confidence fluctuation.
The saving propensity and level of Japanese families is at a high level, which is above
10% in most of years and compared with the USA, it is more than doubled. At the
same time, deposit as the safe asset takes up most of in Japanese family assets and the
proportion of risky financial assets is small. Though the national bond scale directly
held by Japanese families is low, financial organizations in Japan transform huge
—37—
household deposits into financing source of government bonds. According to the
disclosure of central bank of Japan, government bonds scales held by all kinds of
financial organizations in Japan accounts for 30% in its total assets and are higher
than the proportions of the USA and Europe. Seen from the international comparisons,
the domestic holding rate of Japanese governmental bonds is apparently higher than
European and American countries, and the proportion of Japanese government bonds
held by foreign investors is under 10% (He Fan, Huang Yijie, 2012).
Typical characteristic of export-oriented economy makes Yen lack the need to borrow
oversea. Japan keeps strong export and continuously increases the investments in
overseas, so the trade and investment returns of Japan is surplus, and keeps the huge
current accounts surplus; this leads to Yen and Yen assets in short supply beyond the
borders. In 35 years from 1980 to 2014, Japanese current account maintains 30 years
trade surplus, the proportion of GDP maintains at around 2%, and trade deficit
appears in only three or four years. And this becomes the economic base of main
creditor country.
It is mixed blessing that due to the weaker ability of external financing, the
internalization of debts protected Japan’s financial markets from the panic market that
debt crisis countries of southern Europe faced. So, the performance, function and
effect of reserve currencies in overseas borrowing are different in different countries
and areas owing to different conditions.
IV. The risk and prospect of reserve currency to borrow overseas
The issuing country of reserve currency can use domestic currency to borrow overseas,
and it does not have currency mismatch risk and international solvency constraints,
making it avoid the effect of “original sin” that emerging markets usually encounter.
But in fact, reserve currency to borrow overseas faces with a series of risks and
constraints.
Confidence is the immediate cause of the breakdown of Bretton Woods System and
the biggest risk of reserve currency to borrow overseas. The external liabilities of the
USA accumulate in the long term, and when to a certain degree, once non-residents
holding US dollar reserve throw doubts upon debt-paying ability and it may trigger
—38—
the flight of dollar. The U.S. government debt accumulated at overseas is exceeding
the continuously diminishing fiscal capacity (Pan Yingli, 2014). Continuous current
account deficit leads to the rising of the proportion of the net foreign debt balance of
the USA/GDP. When this specific value reaches a certain level, non-resident investors
will stop buying the USA assets and demand higher risk premium. Zhang Yuyan and
Zhang Jingchun (2008) think that issuing countries of reserve currency need to create
the financial products of high returns to attract capital inflow, including high-risk
financial derivatives and assets securitization products; in the process of creating
financial products, it increases the “thickness” (bubble) of currency markets of issuing
countries, and once occurring crisis, it leads to the breakage of debt chain and losing
confidence and this even triggers large areas of financial crisis.
Currency substitution is another risk for reserve currency to borrow oversea. If other
sovereign currency can perform its responsibility as international currency, the
government of each country may reconfigure the currency of reserve assets and
weaken the borrowing power of certain reserve currency. Seeing from the comparison
of NIIP, at the turn of the century, emerging Euro to borrow overseas shows
continuous power, but US dollar to borrow overseas apparently slows down from
2000 to 2007 and it even retrogresses in part of the year.
Though the above-mentioned risk factors exist on theoretical and realistic level, the
prospect of main reserve currency to borrow overseas is still confirmative in short
term and dollar-based international currency system still operate over a long period.
First, safe-haven properties of US dollars decide that during the financial crisis, it is
even more popular. During the crisis, though the USA exports a large number of US
dollar liquidity, but owing to the financial turbulence triggered by crisis, monetary
authorities of each countries especially emerging market countries sharply increase
foreign exchange reserves of US dollars. After Eurozone and Japan launch
quantitative easing monetary policy, the USA assets have safe-haven properties
because it has the advantage on liquidity and the absolutely advantageous reserve
status, so it is popular during the recession; next, US economy is still the bellwether
of the global economy. When global economy begins to revive, the USA becomes the
—39—
chasing object for investors because of the strong revival of its economy. At present,
Federal Reserve has announced the withdrawal of quantitative easing and raising
interest rates is on the meeting agenda. Eurozone caught in deflation crisis and Japan
suffering from consumption tax has a more optimistic prospect; finally, though
international society dissatisfies the dollar-based international currency system, there
are no other currencies or physical assets replacing the status of US dollar. As the
spreading and deepening of this crisis, major world currencies of Euro, Pound,
Canadian Dollar, Australian Dollar, etc. have a sharp depreciation against US dollar.
RMB to US dollar exchange rate keeps the steady rising trend in Asian financial crisis,
but RMB are not with absolute conversions and internationalization, so it cannot
replace US dollars. After crisis, gold price booms and continues to play a role of
traditional safe-haven assets. But gold is a kind of commodity, and it does not have
much value in use. And it cannot be eaten and used, so in a sense, it is not economic
as petroleum. Based on confidence, gold can be unity equivalent. But gold supply
cannot keep pace with economic development; deflation is with high economic
growth during gold standard period and gold standard cannot adapt to the needs of
economic development of contemporary world that fictitious economy is more and
more dominant, so that replacing US dollars with gold cannot be realized (Guan Tao,
2009). In conclusion, other currencies cannot replace US dollars to perform its
responsibility as international currency, and the circulation system of US dollar debts
still continues.
There is no qualitative break at this stage, and it does not mean that there is no
long-term accumulation of quantitative change. The relative decline of status of US
dollar reserve currency and the trend of international reserve currency diversification
from Jamaica System will continue to evolve.
Section Five: Brief Summary
The difference of ability of reserve currency to borrow overseas is larger than the
difference of the order of status of reserve currency. US forms special national debt
capital structure depending on its leading status in international currency system, and
—40—
as the largest net debtors in the world and under the condition of the constantly
increased external debts, US dollar is still capable to constantly and further expand the
debt capacity.
The strength to borrow overseas of other reserve currencies cannot achieve the degree
of US dollars. Euro to borrow overseas as a whole is not weak, and even exceeds US
dollars in the index of stock of bonds; but its own imbalance and mechanism defects
restrict the development of Euro reserve currency to borrow overseas. Yen is a
constant net debtor in borrowing overseas because of its own economic endowment
and financial investment structure.
Though reserve currency has different levels of ability to borrow overseas, it is not
without cost. As the external risks of reserve currency are lower, it easily leads to
domestic risk negligence and maintaining currency confidence is a bigger problem in
a long time.
—41—
Chapter Four:
Reserve Currency and Monetary Policy Autonomy
Section One: Japan and Germany adopt Non Internationalization Strategy in
early stage for the sake of Monetary Policy Autonomy
Worrying that internalization of domestic currency may bring appreciation pressure of
exchange rate and interfere with monetary policy, Germany and Japan rejected the
international usage of domestic currency in 1960s and 1970s (Yuan Dong, 2015).
In the mid of 1970s, central bank of Japan tried to prevent the international usage of
Yen, and Japan mainly worried that large holding of Yen assets by non-resident would
lower the control of Japan’s currency authority for currency supply and increase the
fluctuation of exchange rate (Tavlas, Ozeki, 1992). Since 1980s, the USA pressured
Yen internationalization so as to force Yen appreciation to alleviate trade imbalance of
the USA and Japan and Japanese government began to think that with the raised
position of Japanese economy in the world, Japan hadthe responsibility to play a role
in international currency system. On this background, Yen internationalization can
change from negative to positive. That Japanese government promotes Yen
internationalization and financial liberalization to present basic features of relaxing
capital control first and then domestic financial liberalization further intensifies the
pressure of Yen appreciation. In particular, some policies and measures (for example,
JOM) cannot promote the Yen’s wide cross border and international usage of Yen in
essence, on the contrary, it is convenient for capitals to flow into the stock and real
estate markets, and it boosts the bubble of Japanese economy (Fukumoto Wisdom, 2014).
Even until Japan stopped the intervention in foreign exchange markets in 2005, Japan
stopped the accumulation of foreign exchange reserve. In the late of 1960s and early
of 1980s, Deutsche Bank tried to restrict the international usage of Deutsche Mark
and worried that large capital flow could intervene the stability of domestic currency
(Tavlas, 1991；Thimann, 2007). The measure taken by Deutsche Bank is to control
capital inflow, for example, control on the issuance of valuation bill of Deutsche Mark
in overseas bond markets.
One view is that the non internationalization strategy of German and Japanese
—42—
authorities explains that from 1960s to 1980s, the importance of Germany and
Japan is raised in world economy, but it does not influence international reserve
currency status of US dollars (Eichengreen, 2005). As the worry of monetary policy
autonomy, some small open economies such as Singapore and China Taiwan still
restrict non-resident to hold domestic currency.
Section Two: The Theory and Impact Analysis on Monetary Policy Autonomy
of Issuing Countries of Reserve Currency
I. The general theory on monetary policy autonomy of issuing countries of
reserve currency
Monetary policy autonomy means that in the process of country’s economy from
closure to open, a country decides domestic interest rate and inflation level not being
adjusted passively with the influence of other economy interest rates, price level
changes and cross-border capital flows.
Whether internationalization of currency influences monetary policy, some foreign
scholars study on it from different views. Aliber (1964) and Bergsten (1975) think that
internationalization of US dollar weakens the ability to perform independent monetary
policy and utilize currency depreciation policy. Tavlas (1997) thinks that under
pegged exchange rate system, the internationalization of currency may destroy central
banks’ ability to control base currency owing to the change of preference of
non-resident holders; under floating exchange rate system, internationalization of
currency can lead to sharp fluctuation of exchange rate and influence the effectiveness
of domestic monetary policy; whatever pegged exchange rate system or floating
exchange rate system, the liquidity of reserve currency is decided by preference of
non-resident holders to a great extent so as to weaken policy control ability of issuing
country of reserve currency. And other scholars think that interest margin of domestic
and foreign currency can trigger currency substitution and lead to ineffectiveness of
monetary policy. Domestic documents study on the influence of internationalization
on monetary policy. Kuang Keke (2011) thinks that internationalization of currency
makes currency authorities difficult to monitor and manage currency stock, weakens
—43—
the leverage of interest rate, and to some extent, and triggers the ineffectiveness of
exchange rate adjustment, so as to weaken monetary policy autonomy. In addition, the
development of offshore market makes adjustment difficulty increase. Liu Lizhen
(2005) points out that after internationalization of currency, interest rate effect of a
country’s monetary policy can be damaged and interest rate transmission mechanism
cannot even work. Most of the domestic and foreign documents think that
internationalization of a country’s currency can impact the domestic monetary policy
autonomy.
II. The beneficial effect of internationalization of currency on monetary
policy autonomy of issuing countries of reserve currency
The internationalization of domestic currency can decrease the reliance on foreign
exchange reserve. The constant expansion of a country’s scale of foreign exchange
reserve may lead to inflation effect under the pegged exchange rate system. In order to
keep stable price environment, it needs to adopt monetary sterilization policy. But
monetary sterilization policy is effective in a short time; it can trigger the decrease of
domestic interest rate in long run. In recent years, emerging market countries store
more foreign exchange reserves, in order to deal with the quantitative easing policy of
developed countries and drastic fluctuation of exchange rate among main currencies.
Zhang Shuguang and Zhang Bin (2007) think that the constant accumulation of
foreign exchange reserve makes the balance sheet of central bank encounter severe
currency mismatch, impacts currency supply and financial markets, and finally may
leads to long-term structural distortion。
If domestic currency acts as reserve currency, issuing country does not have the hard
constraint on international liquidity. Theoretically, it does not need to accumulate
foreign exchange reserve and it can isolate the influence of economic external balance
on domestic monetary policy.
III The adverse effect of internationalization of currency on monetary policy
autonomy of issuing countries of reserve currency
In 1960s, Mondale and Flaming put forward famous Mondale-Flaming model.
Through the expansion of IS-LM model to open economy system, model
—44—
demonstrates that fixed exchange rate system of small countries is incompatible with
dependent monetary policy under open economy. After Southeast Asian financial
crisis, Krugman clearly points out that a country cannot achieve three major financial
targets of monetary policy autonomy, exchange rate stability, and free movement of
capital at the same time, but two of them can be chosen at the same time. And this
theory is called “The Impossible Trinity”. Many scholars discuss the relationship of
capital exchangeable degree, exchange-rate system, and monetary policy monotony
with “The Impossible Trinity” and put forward improvement suggestions for model.
Yi Gang (2001) expands the theoretical framework of The Impossible Trinity, and
puts forward formula X+Y+M=2. X, Y, and M respectively represent exchange rate,
monetary policy and capital flow state. Every variable has many solutions from 0 to 1,
and that is, they can form multiple states through the shift.
As the highest level of internalization of currency, reserve currency regards the more
freedom of cross-border capital flow as its requirement. According to “The Impossible
Trinity”, on one hand, it intensifies the fluctuation of exchange rate of reserve
currency; on the other hand, it weakens the autonomy of monetary policy of issuing
country of reserve country. For the latter, its main features are: one is to increase the
flexibility of assessment currency condition of central bank and ensuring currency
stability; two is to limit leverage of adjustment of interest rate; three is that offshore
market triggers the extreme fluctuation of onshore market price. The adverse effect of
reserve currency on monetary policy autonomy is that after a country’s currency
becomes reserve currency, demand and supply of currency does not depend on its
residents, and the preference of reserve currency held by non-resident may become
the factor to influence monetary policy effect. And through cross-border capital flow
and currency exchange, the assets redeployment effect formed by non-resident
because of domestic economy and international financial market, influences the
demand and supply of reserve currency, so as to adjust passively monetary policy of
issuing country of reserve currency.
—45—
Section Three: The empirical analysis on the influence of status of reserve
currency to monetary policy autonomy
I. Theoretical model
Following the traditional quantity theory of money and synthesizing the opinions of
Cambridge school and Keynesian, Friedman put forward representative formula of
currency demand function:
Md
1 dp
 f ( y, w, rm , rx ,
, u)
P
P dt
Thereinto,
Md
P
(1)
means actual currency demand, y means permanent income, w
means the rate of return of non-human wealth and human wealth, rm means rate of
return of currency, rx means rate of return of other assets,
1 dp
means the ratio of
P dt
price change, u means other random factors, y , rm and currency demand are
proportional relationship, w , rx and currency demand are proportional relationship.
The currency of a country becomes the reserve currency, the domestic and foreign
economic variable can influence its demand, and the demand of non-resident becomes
one of influential factors. It is held by non-resident individual or enterprise, or held by
foreign government in the form of foreign exchange reserve. Under this circumstance,
the demand of reserve currency adjusts to:
M d  f ( y, w, rm , rx , P, u)  g (rm , rx , rf , e,  , v)
（2）
Thereinto, the first part means resident’s demand for reserve currency, the second part
means non-resident’s demand for reserve currency. rf means rate of return of
foreign currency assets, e means exchange rate of domestic and foreign currency,
 means stock scale of reserve currency held by non-resident, and v means other
random factors. From formula (2), we can find that under the condition of
unchanged currency supply, the change of rate of return of foreign currency assets
can influence price and interest rate of issuing country of reserve currency, by
influencing the scale of reserve asset held by non-resident acting on total demand.
—46—
The degree of influence decides on the elasticity of exchange rate and reserve
currency stock held by non-resident.
II. Comparison of monetary policy autonomy across countries
Monetary policy autonomy index. There are two classes of the existing index to
measure monetary policy autonomy: One is to measure the capacity of maintaining
domestic interest rate in a country different from that in other countries while not
being passive to be adjusted, such as Glick and Hutchison (2009), Taguchi (2011) and
so on; The other is to measure the explanatory ability of monetary policy shock at
home and abroad to domestic output and inflation, for example Jansen (2008). The
former class of index is more intuitive. We measure monetary policy autonomy index
by calculating correlation coefficient of benchmark interest rate between the country
and the the USA, referring to years of indexes from Aizenman et al. (2010, 2011), that
is:
MI  1 
corr (i, i us )  ( 1)
1  ( 1)
（3）
Where, MA is between 0 and 1 and larger MA value means stronger domestic
monetary policy autonomy index (Yang Yanlin 2012). It should be explained that the
MA index can not measure the autonomy of monetary policy in the United States.
Therefore, in the measurement of relations between reserve currency status and
monetary policy autonomy, measure monetary policy autonomy in the United States
with the fluctuation of basic currency by using MA index to measure monetary policy
autonomy in non-American countries.
Monetary policies autonomy of Eurozone, Japan and the UK. Through utilizing
1-year libor of Eurozone, Japan and the UK, autonomy index of monetary policy of
each economy in 1995-2014 is calculated according to Formula (3), as shown in
Figure 17. Autonomy indexes of monetary policies of Japan and the UK don’t show
increase or decrease with year, except for steady tendency increase of monetary policy
autonomy of Eurozone in 2001-2007.
—47—
Figure 19: Autonomy Indexes of Monetary Policy of Japan, the UK and
Eurozone in 1995-2014
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
1995
1997
1999
2001
2003
2005
Japan
日本
The THE英国
2007
2009
2011
2013
欧元区
Eurozone
USA
Data sources: Reuters; IMF.
Figure 19-22 respectively shows the autonomy indexes of monetary policies of
Eurozone, Japan and the UK in 1995-2014 and the reserve percentages of officially
held Euro, Yen and Pound around the world. There is no obvious correlation between
two parts. In other words, interaction between monetary currency autonomy and
reserve currency status of Euro, Yen and Pound, the three reserve currencies only next
to US dollar, is not obvious.
Figure 20: Autonomy of Monetary Policies and Officially Held Euro Reserve
Percentage around the World of Eurozone in 1995-2014
—48—
30%
90%
80%
25%
70%
20%
60%
50%
15%
40%
10%
30%
20%
5%
10%
0%
1995
0%
1997
1999
2001
2003
2005
The percentage of Euro in
欧元在国际储备资产中的占比
international reserve assets
2007
2009
2011
2013
Independence indexes of monetary policy
欧元区货币政策独立性指标（右轴）
of Eurozone (right axis)
Date sources: Reuters; IMF.
Figure 21: Autonomy of Monetary Policies and Officially Held Yen Reserve
Percentage around the World of Japan in 1995-2014
8%
90%
7%
80%
6%
70%
60%
5%
50%
4%
40%
3%
30%
2%
20%
1%
10%
0%
0%
1995
1997
1999
2001
2003
The percentage of Yen in
international reserve assets
日元在国际储备资产中的占比
2005
2007
2009
2011
2013
Independence indexes of monetary policy
of Yen (right axis)
日本货币政策独立性指标（右轴）
Data sources: Reuters; IMF.
Figure22：Autonomy of the UK Monetary Policy and Percentage of Global
Official hold Pound Reserve in 1995- 2014
—49—
6%
90%
80%
5%
70%
4%
60%
50%
3%
40%
2%
30%
20%
1%
10%
0%
0%
1995 1997 1999 2001 2003 2005 2007 2009 2011 2013
Percentage of Pound in international
reserve asset Independence 英国货币政策独立性指标（右轴)
英镑在国际储备资产中的占比
index of the UK monetary policy (right axle)
Data source: Reuters; IMF
Autonomy of the the USA monetary policy. Figure 23 shows the fluctuation rate
of the USA benchmark rate and the percentage of UA Dollar in global official foreign
exchange reserve, and they do not have any obvious relation.
Figure 23: Autonomy of the the USA Monetary Policy and Global Official Hold
US Dollar Reserve in 1995- 2014
1995
1998
2001
2004
Percentage of US Dollar in international reserve asset
2007
2010
2013
Libor fluctuation of US dollar in a year(right axle )
Data source: Reuters; IMF
Section Four: Conclusion
Theoretically, a country currency as a reserve currency will weaken the
autonomy of domestic monetary policy, but the severity of influence is dependent on
the degree (scale), exchange rate elastic of currency and policy choice of current
currency of the reserve currency. According to the initial analysis of the situation in
America, Euro zone, Japan and UK, the developing into reserve currency has no
influence on the autonomy of its currency policy, and the main reasons are that first,
—50—
except for US Dollar, the portion of Euro, Yen and Pound would not change at a big
extent in official-worldwide foreign exchange reserve, which has a limited influence
on the total requirement of currency; second, the reserve currency is in accordance
with flexible floating exchange rate system. And the adjustment of exchange rate
relieves the impact of non-resident reserve currency requirement on domestic
monetary policy; third, in the internationalization process, the America and Germany
both pay attention to curbing inflation and stabilizing the domestic economic finance
as the prior goal. The status of exchange rate of US Dollar in American
macroeconomic policy is constantly decreasing. However, the former Federal
Republic of Germany not only initiatively permits the free floating of Deutsche Mark,
but also adjusts regulatory measures according to the concrete situation of
cross-border capital flows and frequent projects. Thus, the loss of autonomy of
currency policy is avoided in the internationalization process.
—51—
Chapter Five: Main conclusions
Firstly, the costs and benefits of reserve currency are related with the international
status of the currency. If the currency enjoys higher international status or in
monopoly status in international currency system, currency- issuing countries will
gain more returns and undertake smaller risks; on the contrary, if the currency is in
lower international status, the country will face with more risks than returns. If the
domestic currency is internalized or turn into reserve currency which is beneficial for
issuing countries to win international reputation and status, only the prosperous
economy can turn it into strong currency. In the middle of 1990s, the proportion of
Yen in global reserves reached the peak of 7%. After Japanese economy experienced
long-term stagnation, the proportion of Yen in global reserves gradually slid to 3-4%.
The international status of Japan and Yen are not what they used to be.
Secondly,
the
structure
of
the
international
currency
system
is
center--subcenter--periphery, which also determines that there is also the level of
center-subcenter in the structure of the international reserve currency. In the system,
certain reserve currency acts as the standard currency (or central currency and key
currency), and other reserve currencies are just the general international currencies. At
present, US dollar is in the central status undoubtedly with unique and distinctive
advantage status, thus, US dollar cannot be used for costs and returns of reserve
currency to measure advantages and disadvantages of currency internationalization or
non-internationalization.
Thirdly, the function for the medium of exchange is the most basic function of
international currency. Throughout the internationalized process of main reserve
currencies, the trade surplus is always as a start. The increase and accumulation of this
kind of currency promotes the position of one in international financial market,
causing the development of other functions of domestic currency from its
internationalization. The “current account deficit, capital account surplus” is an
approach for domestic currency output, but no evidence shows it is the only approach.
Neither different directions for trade balance of each issuer of reserve currency nor the
—52—
non-correlation between the change of each country trade balance and the change of
reserve currency percentage shows the uniqueness of this approach at the data level. It
is worth noting that the economies which has smaller economic size or bigger
foreign-trade dependence is difficult to ensure the stability of domestic economic
finance, through currency output in the way of trade deficit or capital outflow during
domestic currency internationalization. The country with larger economy size has
stronger autonomy for domestic economy and higher tolerance for “Triffin Dilemma”.
In
addition,
balance
of
international
payment
and
domestic
currency
internationalization are two different problems in nature, so the imbalance of
international payment cannot be attributed to domestic currency internationalization.
Fourthly, obtaining the low-cost financing from the world is the important returns of
reserve currency status. The strength of this advantage is related to the reverse
currency status, the natural advantages of issuing country of reverse currency, and the
concrete objects like debt holders. The ability to borrow overseas of the reverse
currency is formed along with the evolution of specific historical conditions, which is
relatively slow and dynamically changing. The reverse currency courses of growth are
different for US Dollar, Yen and Euro. The unique debt capital structure of US Dollar
is unlikely to be imitated by the other catching-up currencies, thus it will keep a
long-term advantage for the overseas borrowing.
Fifthly, in theory, one country’s currency becoming the reverse currency will reduce
the autonomy of that country’s monetary policy, while this extent is determined by the
level (scale) of reverse currency, monetary elasticity of exchange and the policy
choice of monetary authority. Seen from the preliminary analysis on conditions of the
the USA, Eurozone, Japan and the UK, becoming the reverse currency has no
significant influence on the autonomy of their monetary policy, which is also due to
three factors above.
Sixthly, the international core of one country’s currency is the natural selection
process propelled by the market force and strengthened by the network effect.
Catching-up countries in the global competition shall have a complete knowledge and
sufficient patience of their internationalization of currency. While striving for
—53—
participation in harmonizing and maintaining the stability of existing international
currency system, grasping and accumulating the available opportunities is the careful
and sharp-sighted tactical arrangement.
(Research group members: GUAN Tao, JIA Ning, LEI Dianfa, XIA
Zuorong)
—54—
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