Is Threat on US Dollar From Renminbi Overstated? Currencies whose trading patterns closely mirror the U.S. dollar tend to have large dollar reserves. Is this statement true? The reason that the U.S. dollar has remained the preeminent reserve currency despite a long-term decline in and a relatively smaller U.S. economy is the creation of the “dollar zone”. Moreover, in countries whose currencies are more stable against the dollar than the euro, a reserve composition that favors the dollar produces more stability in the domestic currency. The higher the co-movement of a given currency with the dollar, the higher the economy’s dollar share of official reserves. Two thirds of the variation in the dollar share of foreign exchange reserves is related to the respective currency’s dollar zone weight. The logic underlying both private and official behaviour is straightforward. The dollar looks less risky as an investment or a borrowing currency the more closely the domestic currency moves with the dollar. The continued relatively rapid growth of the Chinese economy, with the opening of the capital account and floating of the renminbi, still might NOT lead to the renminbi surpassing the dollar in global reserve holdings. On the other hand, if in the future the renminbi showed a significant movement against the major currencies and if its major neighbors’ and trading partners’ currencies started tracking that movement, then it could be said that a “renminbi zone” was developing. If that came to pass, it seems more likely that global central bankers might choose to hold a larger percentage of renminbi, perhaps even close to their currencies’ renminbi zone weights.
Posted on: Wed, 10 Dec 2014 13:23:15 +0000
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