Unit 45 of Trade & Export Online outlines the ‘nuts and bolts’ of managing currency exchange risk. This article takes a step back to look at a wider picture. Specifically the role of the US Dollar (USD) as the key reserve currency – namely a strong currency that other central banks will hold as a key element of their reserves.
The media in recent weeks and months has highlighted the growing trade dispute between the US and China. The EU has also sought to break ranks with the US in supporting trade with Iran. This despite the imposition of sanctions by the US against Iran and the ability of the US to penalise overseas companies with US interests who ignore such measures. Countries such as Iran, Russia and Turkey have also been active in seeking ways in reducing dependency on the USD in the face of sanctions.
This has given rise to some speculation that, without widespread support, the US’s assertive use of its power as the prime reserve currency could undermine the central role it has played since the Second World War. Part of this argument rests on the US’s heavy budget deficits and a long-term growing debt burden that makes it increasingly reliant on overseas investors.
So need we doubt the dollar in its central reserve currency role?
Well, the simple answer is ‘no’! Certainly in the short term…
- Something like two-thirds of central banks' reserves are denominated in USD. It would take a seismic event to change that picture.
- Alternative currencies (the Euro, the Yen and Yuan) for a variety of reasons are not ready to take the strain.
- History shows that such changes happen almost glacially slowly. The US was surpassing the UK as an economy as far back as 1872. It took until the Bretton Woods Agreement 1944 for the USD to formally supersede Sterling, with alternative initiatives along the way like the Gold Standard.
A cursory review of the EUR/USD rates in recent months reveals a strengthening of the USD, partially on the back of stronger economic performance than the eurozone. Fortunately, it is these trends that drive what we need to do in managing short-term risks. So much of what is in Unit 45 still holds good despite the wider developments, but in shaping currency risk management do try to obtain advice from suitably qualified, and regulated, specialists.