Monday, August 13, 2012

The Currency Enigma

The epicenter of the recent recession is undoubtedly the United States of America but this financial contagion affected the entire world in different magnitudes.  In Europe, the crisis led to the other crisis which impacted them in a real hard way and it is now becoming extremely tough for them to come out of this situation, on the other hand the developing countries combated the American crises comfortably but the impact on their financial health is quite palpable and deplorable. BRICS definitely need a life supporting system for survival at this point of time in terms of rapid public investment, more employability and steep reduction in deficits but for all of it to happen the emerging economies has to reign in the depreciation of their currencies.

And in the mean time after the American sovereign’s downgrade it was somewhat nice to predict that the capital flow in emerging economies was inevitable and which would boost the financial health of the countries, a perplexing situation emerged which led the global investors to flock into the (USA- where it all started) US dollar, which was considered as a safe haven and the other currencies depreciated rapidly.

This was a stark reminder of the grim reality confronting the world – the lack of a credible alternative to the US dollar even as the fundamentals of the US economy are no longer as strong as earlier. Though because of immense liquidity of markets in dollar assets, the depth of the markets in dollar assets that results in tight bid ask ratio and wide-spread availability of derivatives to hedge dollar exchange-rate risk, proves that US dollar is the currency superpower but there are many economists who believe that the dollar’s hegemony wont sustain for long from now on. “The Economist” has recently estimated that USA has lost ten years of economic progress because of the Great Recession meaning that its economy is back to where it was in 2002. And secondly “Triffin Dilemma” has become acute for USA with an urgent need to curb its twin deficits.
It is likely that the US Dollar will no longer enjoy a pre-eminent status but will share it with other currencies. The Australian Dollar, the Canadian Dollar, the Swiss Franc and the Scandinavian currencies have all attracted safe haven flows in recent years with central banks increasingly diversifying their foreign exchange reserves into these currencies\assets. But by far the most serious challenge to the dollar today is posed by the Chinese Renminbi.

China has taken several strategic steps to promote international use of its currency. Entering into currency swap arrangements with several developing countries in Asia and Africa. In April 2011 China led BRICS initiative to establish mutual lines of credit in local currencies to protect intra-BRICS trade from foreign exchange risk. Trade settlement is only one of the steps in internationalizing the Renminbi. In January 2011, Bank of China started offering Renminbi deposit accounts in New York and also took steps that included in approving the use of Renminbi for FDI in China.

Though China is trying its best to make its currency the next internationally accepted currency but it fails to meet several criteria normally required of a reserve currency such as full convertibility, deep and liquid bond markets and secure legal structure in the country.

This shows that the stage is now set for the emergence of multi-currency based global financial system with several currencies competing for dominance and no single currency having the overwhelming status enjoyed by the US Dollar since World War II. 

  • ·         Article - Currency Conundrum in “The Indian Banker”,  June 2012 by Mr.Radha Syam Ratho.
  • ·         Article on Shadow Currency by Mohi-uddin,