The depreciation of the US dollar raises once again the question of how long the natural life of a reserve currency can be.
Last month I came across an interesting research paper by an investment bank on the outlook for the US dollar. The paper includes some interesting philosophical reflections on the sustainability of a currency as the world's reserve currency. The paper gives a brief account of the long history of reserve currencies and draws attention to the interesting phenomenon that, as in the case of the position of a country being the superpower of the world, it seems to be a "natural cycle" of around 100 years long. This has held true ever since the middle of the fifteenth century, with the Portuguese supremacy spanning about 1450-1530 to the Spanish (1530-1640), the Dutch (1640-1720), the French (1720-1815), the British (1815-1920) and the US from then.
Not being a historian, I am not qualified to comment on this natural cycle theory of world hegemony. But, if indeed there is such a natural cycle, reflecting the intuitively inevitable re-balancing of economic power, having regard to the different growth, savings and investment rates of the major economies, the implications for the foreign exchange market in the next twenty years or so are quite interesting. I am, of course, speaking about the possible and theoretical long-term trend rather than the shorter-term outlook, which is of more immediate interest to investors and portfolio managers. There is, in any case, no way of planning for something that may or may not materialise in twenty years' time. What is clear, however, is that the economy of the reserve currency of the world is currently facing structural problems, which have been described, even in the home jurisdiction, as serious and unsustainable, and are causing worldwide concern, particularly at the policy level. The low savings rate, the large current account deficit and now also the large budget deficit are the familiar issues, and associated with these is the question of how willing are those economies with surplus savings to continue to finance those deficits.
The short answer is not indefinitely, particularly when rapidly increasing amounts are involved. And this suggests the possibility of the US dollar at least becoming less popular as a reserve currency if the imbalances persist. But the worrying thing is that the almighty market, made ever more potent by information technology, may compress what is in history an evolutionary process into a destabilising crisis. To be sure, the policy options are available positively to address the imbalances in the US and pre-empt brutal adjustments that are not in the interest of anybody. Perhaps this would prolong the reign of the US dollar as the world's reserve currency to well beyond the "natural cycle" of about a hundred years. In any case, few are suggesting that the current phase of weakness is the beginning of the final slide. Many are still happily holding on to US dollar assets and US Treasury securities are still in great demand.
And there are for the time being no dominant, alternative candidates for the world's reserve currency. There are other types of structural issues in Europe and Japan that inhibit their currencies from assuming a leading role. The story may be different in twenty or thirty years' time, and in this connection I must point out the possibility of the renminbi becoming such a candidate if the pace of reform, liberalisation, growth and development on the Mainland continues apace. This, of course, is a big "if". But of much less doubt is the renminbi becoming a major international currency used for international transactions, particularly in this region. The fact that the Mainland is now the largest trading partner of a number of economies in the region - a region of increasing economic and trade integration - speaks clearly. There is a case, for convenience and for the further promotion of closer economic relationship, for the much greater use of the renminbi as the currency for settling trade transactions between the Mainland and its trading partners, without having to go through the US dollar. There is also the possibility that, consequently, the renminbi will in time emerge as the anchor currency of the region.
We await with keen interest these developments. We are confident and hopeful of the increasingly international role that the renminbi can play. But there is more to just being confident and hopeful. We need also to get ourselves ready in every way we can to contribute to and take advantage of these possibilities, hence our efforts in improving our financial infrastructure through the inclusion of the renminbi as one of the key currencies for effecting transactions. We have started, quite successfully, with a few areas of renminbi banking business. I hope we will be able to do more. This arguably is the most important area in the future development of the financial system of Hong Kong and its status as an international financial centre.
Joseph Yam
6 January 2005
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