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On the world’s biggest stage for the world’s most powerful leaders, an official representing the world’s most populous nation more or less called for the end of the dollar as the world’s reserve currency. A pretty big blow for the greenback, one might think. Yet throughout this week’s G8 summit in Italy, the dollar strengthened against most currencies, save the yen.
That is a reminder of the fickle ways of currencies. For all the tough talk, foreign central banks are not yet turning away from the dollar. To the contrary, during the first quarter of this year, foreign dollar claims increased by 2 percentage points to almost two-thirds of total allocated reserves, according to International Monetary Fund data.
Furthermore, while currencies dance to many tunes, traders can play from certain songbooks for years. A while back, so-called carry trades were all the rage. Now it is all about risk. The dollar, for example, tends to be bought when investors feel perky and to be sold when nerves start to jangle again. That is partly because the US’s bond markets are the most liquid in the world and, in uncertain times, that liquidity enjoys a premium.
More than two-thirds of all the world’s dollars are held outside the US, many of them by emerging countries. In time, it makes sense for their central banks to switch some of their reserves into other currencies that more closely reflect their trade flows, such as the real, the rouble and even, eventually, the currently unconvertible renminbi. But there are reasons beyond finance why the dollar is the world’s reserve currency. The US remains the dominant global superpower, with a history of political stability. Would central banks ever trust most of their funds to a non-democracy, given how such states often end?
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