As the US congress passes an increase in the debt ceiling without a crisis the dollar world reserve currency status is not being mentioned. On the other hand when Tea Party activists shut down the US government and nearly made it impossible for the USA to pay its bills the dollar world reserve currency status was imperiled. Why should anyone interested in Forex currency rates be concerned about the dollar world reserve currency status? Here are a few thoughts on the subject, including suggestions for trading in the future.
Dollar World Reserve Currency Status
The status of being the world reserve currency has not always been held by the US dollar. When Spain ruled much of the Western Hemisphere and brought shiploads of gold and silver back home the Spanish dollar, the piece of eight, dominated all other currencies. This was from the seventeenth to early nineteenth centuries. Currencies used to be equal to a given amount of gold. Thus the reserve currency was gold. As the British Empire rose to its heights in the 19th century until 1944 the British Pound Sterling was considered the world reserve currency. Then the Second World War devastated Europe and much Asia. The remaining global economic power was the United States. At the end of World War II the dollar was pegged at $32 to an ounce of gold and all currencies were likewise pegged to the US dollar. In the aftermath of World War II US aid and trade dominated the non-Communist world. When countries traded with the USA and made a profit they simply kept the dollars they received as currency reserves. This was the beginning of the dollar reserve currency status. Even when the USA went off the gold standard in 1971 the dollar remained the preferred reserve currency of nations around the world. The USA was simply the dominant global economic power and the faith and trust in the US government to pay its bills went unquestioned.
What a Little Tea Party, and Debt, Can Do
The dollar reserve currency status has eroded over the years. A large part of this is because of the ever mounting US debt. But, a shock to the Forex trading world occurred this last fall when it occurred to people around the world that the United States government might actually renege on its sovereign debts. What happened was that a conservative wing of the Republican Party blocked action in the US House of Representatives to extent the US debt ceiling. Without the authority to issue bonds the US Treasury would have been unable to pay interest on or return principal on US Treasury bills. This was a shock to Forex traders as it brought into question the dollar world reserve currency status. Why would a nation want to hold US dollars in reserve if the value was constantly falling and it might not be possible to collect on US debt? To the extent that nations are concerned about a possible of demise of the US dollar as a reserve currency or to which they might believe that there might be replacements such as the Yen, Euro or Chinese Yuan, nations might start to sell dollars and rid themselves of US Treasury debt. To the extent that this happens it will be wise to short the USD in trading. However, suggestions that the Yuan especially will overtake the dollar are premature. Our belief is that a more likely scenario will be a real estate and manufacturing crisis in China and a downward pricing of the Yuan against the major currencies. To the extent that movement of the dollar both up and down are possibilities, Forex options are typically a wise choice.