A widespread misconception among the currency market participants says that there is only one world’s reserve currency – the U.S. dollar. While it is true that the greenback is the world’s reserve currency, it does not mean that it is the only one. All it means is that it is the dominant one.
What is the world’s reserve currency, and what other currencies are also used by foreign nations to keep their foreign reserves? Is there a privilege for a country that its currency has the world’s reserve status?
Can the Euro Challenge the U.S. Dollar’s Role as the World’s Reserve Currency?
Also called an “anchor currency”, the world’s reserve currency is a foreign currency that national banks and other financial institutions held as foreign reserves. The chart above shows that there are many other reserve currencies besides the U.S. dollar, with the Euro coming in a distant second place. The so-called “exorbitant privilege” of having the world’s reserve currency status means that the country (i.e., the United States) will not have a balance of payments issue because it literally can import goods in its own currency. However, many economists consider this to be a burden rather than a privilege.
Coming back to the table above – can the Euro challenge the U.S. dollar’s status? After all, the Euro seems to be the only contender to it.
The answer is that it might. With the new sovereign debt issuance in response to the coronavirus pandemic, there is suddenly a rival for the U.S. Treasury market. Let’s do some math. The SURE (Support to Mitigate Unemployment Risk in an Emergency) and the Next Generation EU programs account for about EUR850 billion. If we add here the balance of payments assistance programs, we have roughly one trillion Euros. With a T. On top of that, we have the large sovereign debt issuers in Europe, namely Germany, France, Italy, or Spain, but also the supranational issuers (e.g., EIB – European Investment Bank and ESM – European Stability Mechanism).
For once, the U.S. Treasury has massive competition in the form of an unexpected rival. The issuance of common debt was long viewed as one of the final steps to complete the union in Europe, but it has found many opponents throughout time. As it turned out, a pandemic was needed to push away the fears.
In the macro-landscape, things do not happen overnight. Therefore, the dollar will remain dominant, but the gap (i.e., the distance between 60% and 20% between the U.S. dollar and the Euro on the chart above) is poised to narrow in the years ahead. By how much, it remains to be seen.