Most Forex traders view the US dollar as a safe haven currency. After all, the USD accounts for nearly two thirds of foreign currency reserves held by the central banks of the world. The Euro holds second place with just under a fourth of all currency reserves. There are a number of advantages to the USA of having what amounts to the world reserve currency. Virtually all commodities are denominated in US dollars. The USD is part of eighty-five percent of all Forex trades. Many foreign contracts are written in US dollars even though the USD is not the home currency of either party. And, when the United States wants to borrow money to finance its ever-growing debt, everyone still is willing to purchase United States Treasuries with their currency. There is no risk in the short term that this situation will change because of the fact that the US economy is far and away the largest in the world. However, there are a couple of concerns regarding the status of the dollar as the world reserve currency. These are the risk of debt default due to a malfunctioning political system in the USA and continuing long term devaluation of the USD.
Risk Hedging versus Speculation
Foreign currency trading serves two purposes. First and foremost the Forex market exists to facilitate international trade and the movement of wealth. Companies that do business in the international arena and people who earn their money in unstable regions of the world prefer a stable currency for doing business and storing wealth. The second purpose is speculation. Currency speculators do not especially care for stable currencies. Rather they would prefer that the USD is going up or down but not standing still. The status of the USD as the world reserve currency affects its use in international trade and it especially affects the use of the USD as a safe haven currency.
Short versus Long Term Competition for World Reserve Currency Status
Given the economic weakness of the European Union and speculation as to its breakup the Euro poses no short term threat the USD as world reserve currency. China is intent on making the Yuan an international currency. However, the Yuan exchange rate is fixed within a government prescribed trading range. And, the Yuan is to a large degree an instrument of economic and political policy of the ruling Communist regime in Beijing. The Chinese economy is a fraction of that of the USA and would need to continue its breakneck pace of the last couple of decades to catch up. And cracks are showing in the Chinese economic miracle just recently addressed by the Communist hierarchy. In all likelihood no one is going to want to store value long term in Yuan when they can put all of part in the USD, Euro, British Pound, or Swiss franc. To be a world reserve currency means that the currency needs to engender confidence. The Euro is currently questionable. None other is as strong. And until China lets its currency float with the market it will engender no confidence as a safe haven or world reserve currency.
Threats to the USD as World Reserve Currency
The USD will probably adjust downward a bit as the Fed continues its quantitative easing program. It may jump up as the Fed backs off and interest rates go up. But over time a weaker dollar will help the USA bring manufacturing back home and stimulate the economy. If the dollar continues to fall, year after year, it could eventually be too cheap to be a world reserve currency. After all who wants to hold a currency that is on its way to being worth pennies on the dollar? This scenario is not likely to happen and certainly not in the near future. However, a viable threat is the current dysfunction of the US government. Those who wish to park their wealth in a stable currency are not pleased to think that tomorrow they will not receive interest on their US treasuries or that the US could default on its sovereign debt. To quote Abraham Lincoln, if destruction be our lot we must ourselves be its author and finisher.
Alternatively, we have met the enemy and he is us, Pogo Possum.