Thanks for your comments on Reserve Currencies on Friday. I remember David mentioning many years ago that to be a reserve currency a country must have democracy and military might. If this is true China would not have a chance in the foreseeable future. I would love to learn your views on this. Please advise and thanks again.

Eoin Treacy's view

Thanks for your comments on Reserve Currencies on Friday. I remember David mentioning many years ago that to be a reserve currency a country must have democracy and military might. If this is true China would not have a chance in the foreseeable future. I would love to learn your views on this. Please advise and thanks again.

My view - Thank you for this question which may be of interest to subscribers. The question of reserve currency status has become quite popular this year because of the massive monetary and fiscal response to the pandemic and the rebound in gold.

Militarily, the USA still has an apparent advantage. The big question militarily is that the pace of technological innovation continues to accelerate. The evolution of cyber, drones, space technology, hypersonic missiles and vehicles all have the potential to represent some form of first strike optionality. Nuclear weapons have ensured the absence of major wars between the major powers for seventy years. As soon as weapons are developed that can circumvent nuclear weapons, the international risk profile will change meaningfully and potentially already has.

Rather than focus specifically on democracy a clear trend of both high governance and improving standards are required. International payments rely on the faith and sustainability of a regulatory environment. Democracies tend to be volatile but their systems of laws tend to be long lasting and predictable. Dictatorships or Autocracies often appear stable politically but their regulatory environments tend to be heavily subject to the whim of whoever is in power.

The challenge today is that the political volatility inside democracies has increased substantially. Internal divisions, abandonment of international treaties and less patience with diplomacy. The disparity in incomes and the big question of how to address inequality is likely to be the defining issue of this decade.

At the other extreme, China is clearly aiming for a greater international footprint with a view to setting up a competing currency regime. The evolution of a digital currency is aimed at circumventing the internationally accepted Swift system. It would also serve the dual purpose of creating an alternative to the dual currency system as it currently exists. The challenge for China is it needs to create greater confidence in the renminbi before international investors will be willing to hold them as an asset. That’s a very long-term project.

Ultimately, the global run-up in debt is unlikely to ever be paid back. Instead a war for global domination will likely end with the reforming of the global order where the loser experiences profound debt deflation and inflation takes care of the debt of the victor.