The Distortions of Doom Part 2: The Fatal Flaws of Reserve Currencies
The way forward is to replace the entire system of reserve currencies with a transparent free-for-all of all kinds of currencies.
Over the years, I’ve endeavored to illuminate the arcane dynamics of global currencies by discussing Triffin’s Paradox, which explains the conflicting dual roles of national currencies that also act as global reserve currencies, i.e. currencies that other nations use for global payments, loans and foreign exchange reserves.
The four currencies that are considered global are the US dollar (USD), the euro, the Japanese yen and China’s RMB (yuan). The percentage of use in each of the three categories of demand for the reserve currencies–payments, loans and foreign exchange reserves–are displayed below.
Many observers don’t seem to grasp that demand for reserve currencies extend beyond payments. Many of those heralding the demise of the USD as a reserve currency note the rise of alternative payment platforms as evidence of the USD’s impending collapse.
But it’s not so simple. Currencies are also in demand because loans were denominated in that currency, so interest and principal payments must also be paid in that currency. There is also demand for the currency to be held as foreign exchange reserves–the equivalent of cash to settle trade imbalances and back the domestic currency.
Notice the minor role played by the yen and yuan, despite the size of the economies of Japan and China. There’s a reason for this that’s at the core of Triffin’s Paradox: any nation seeking to issue a reserve currency must export its currency in size by running large, permanent trade deficits (or an equivalent mechanism for exporting currency in size).
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