Currency re-evaluation: A looming reality or a wild card?
The subject of global currency revaluation has sparked a lot of controversy over the years; some commentators are counting down the days until it will no longer be a choice, and others are adamant that such a possibility does not exist.
Currency standardisation did not appear until 1940, when two World Wars and an impending second Great Depression drove the Allied Nations to the Bretton Woods agreement. This saw the international gold standard pegged to the U.S dollar. Exchange rates would remain, in order for the Allies’ to ensure that their currencies continued to stay within at least a 1% parity with the USD by relying on money supply measures and forex trading.
This meant that gold was knocked off its pedestal as the main reserve currency, and was replaced by the US dollar. The idea seemed good, at the time, but it eventually become unhinged. The discontinuation of USD to gold conversion in 1971 by the Nixon Administration effectively put an end to Bretton Woods. By 1973, currencies began floating freely and currency trading as we know it today began.
In more recent years, the 2008 economic crisis shook the world to such an extent that it had the potential to stir governments into re-thinking international monetary policy. That being said, if central banks were to start thinking about revaluating global currency, they would need to accept their own limits in executing money supply measures. Even when the monetary crisis peaked, none of them were inclined to give up national fiscal policy, and currency revaluation was dismissed.
Recently, Special Drawing Rights (SDRs) have come onto the radar, especially since China was added to the pool in late 2016. SDR’s were devised in the 1960s, in response to a looming crisis in the US. They were created by the IMF in 1969 to supplement the existing official reserves of member countries. Countries could exchange SDRs for hard currency at the IMF.
From 1950 to 1969, the German and Japanese economies recovered from the war and the US share of the world’s economic output dropped from 35% to 27%. They also incurred a negative balance of payments, and a massive debt that was fuelled by the Vietnam War. Adding to their woes was growing Inflation that caused the dollar to become overvalued. By 1966, non-US central banks held $14 billion, while the United States had only $13.2 billion in gold reserve. Of those reserves, only $3.2 billion was able to cover foreign holdings as the rest was covering domestic holdings.
The SDR was equivalent to 0.888671 grams of gold then, or one US dollar, and after the Woods system fell apart, the SDR became valued by a ‘basket of currencies’. Its units were made up of USD, EUR, GBP, JPY, and, as of late, RMB.
Could this be the perfect potential reserve currency? Unfortunately, the SDR currently lacks liquidity, meaning there aren’t enough baskets available to back international fiscal policy.
However, China has always been an advocate of the SDR. With the country becoming more involved in global financial matters, and its currency now included in the basket, it’s hardly surprising. Chinese GDP is predicted to take top spot in the rankings, with the US falling to second place in the next twenty years, and many economists are advocates for the RMB (Renminbi) to become the world’s next reserve currency – regardless of its current trading limitations.
If 2017’s political turmoil has shown us anything, it is that geopolitics will continue to impact forex trading and currency markets. Revaluation will continue to be an interesting possibility, and in the current political and economic landscape, definitive answers regarding its eventual implementation are a risk that most pundits are not willing to commit to.
This article is written by Samantha Robb, a staff writer at FXTM