This is an article that we use ourselves to learn basic financial theory. When it comes to DeFi business, what the blockchain industry lacks most is basic industry knowledge. Compared with the macro arguments of Hayek, Keynes, etc., a more specific basis is more suitable for the design of blockchain protocols and token mechanisms.
The glacier of global finance: For decades, the currency held by the central bank as foreign exchange reserves has basically remained stable. The changes in the composition of these assets can at best be described as snails. However, geopolitical changes and technological revolutions are reshaping the global economy and the international use of currencies. These reasons and the pandemic of the new crown pneumonia may further accelerate the transformation of central banks’ foreign exchange reserves.
status quo
There are currently about 180 national currencies, but only a few are widely used in international transactions, such as invoicing, paying for imports, issuing debt or investing overseas. These currencies include the U.S. dollar, the euro, and to a lesser extent the yen, pound sterling, and other currencies. When a crisis hits, companies and investors often rely on the U.S. dollar for safety.
Central banks also hold the same currency as foreign exchange reserves for a long time. This is not surprising. These reserves are designed to support the above-mentioned international transactions, so that national authorities can provide funds for international payments, intervene in the foreign exchange market, and provide foreign exchange for domestic agents.
Slow changes in reserve holdings
A paper by IMF staff analyzed the composition and driving factors of reserve currencies held by central banks based on the new data set, and how these driving factors changed.
An important finding is that given the dominance of the U.S. dollar (and to some extent the Euro) internationally, the changes in central bank holdings of reserves have so far been almost minimal.
For example, despite China’s increasing status in the global economy, the RMB has only a small foothold in global transactions, such as the issuance of foreign debt or transactions in the global foreign exchange market.
The paper also found that financial linkages appear to be a key driver of reserve currency holdings, and that this trend has become increasingly apparent in the past decade. This shows that as long as the dollar continues to dominate global finance and trade, its dominance as a reserve currency appears to continue.
However, just as a slow-moving glacier can unexpectedly flood forward, so too can the currency composition of foreign exchange reserves undergo a sudden and unexpected acceleration.
The future of reserve currencies
The paper proposes many economic and financial trends that may affect the composition of reserve currencies in the future. Geopolitical and technological developments may be as important as economic factors, coupled with the current COVID-19 pandemic, may accelerate future transformation. Potential drivers of change include:
Changes in international finance: The strong response to the European Commission’s large-scale bond issuance in October highlights the potential demand for dollar-denominated debt substitutes.
For example, emerging markets and developing countries like China can also issue bonds denominated in the currencies of emerging creditor countries to help meet the growing demand for financing. Our paper found that the monetary unit of public debt is a particularly important determinant of foreign exchange reserves in emerging markets and developing countries, which may reflect the expectations of central banks to hedge debt-related risks.
Changing trade links and tax receipts may also change the demand for international currencies. The epidemic and recent trade tensions have highlighted the fragility of global supply chains. Countries are now more than ever concerned with critical supplies. The shift to localized production will reduce the demand for international currencies.
At the same time, reduced reliance on a single trading partner may diversify currency demand. The recently signed Regional Comprehensive Economic Partnership in Asia (rcep)-a free trade agreement between 15 countries in the region-may mark the current share of international reserves Small alternative currencies will play a bigger role.
The credibility of the country’s policy is the basis for people’s trust in their currency. The new crown pneumonia pandemic highlights the need for current and potential issuers to formulate sound health and economic policies to maintain their growth potential.
The international use of currencies can also reflect strategic considerations. For example, the decision-making of a reserve currency portfolio may be influenced by foreign policy factors and security relations. The consequences of trade tensions and international sanctions may prompt countries to consider changing their foreign exchange reserves and also prompt potential issuers to seek to internationalize their currencies.
The epidemic has accelerated the advancement of finance and payment technology. Potential competition from private issuers such as Diem (a Facebook-based blockchain-based payment system) has stimulated central banks to accelerate the process of central bank digital currency and cross-border payments. The European Central Bank (ecb) and the People’s Bank of China (pboc) are all exploring the issuance of central bank digital currencies because they may increase the demand for their currencies.
Advanced technology platforms can also help new currencies overcome certain advantages of existing currencies. In the future, the central bank will have to reconsider the composition and holding methods of reserve currencies based on the public or private adoption and use of digital currencies.
There is currently no sign that the composition of the central bank’s reserve currency has undergone major changes. However, the slow changes in recent decades should not be seen as a sign of the future. There are great uncertainties in global economic and financial trends, as well as geopolitical and technological developments, so there may be more dynamic space for change in the future.
