!DOCTYPE html PUBLIC "-//W3C//DTD XHTML 1.0 Strict//EN" "http://www.w3.org/TR/xhtml1/DTD/xhtml1-strict.dtd"> Streamline Training & Documentation: The Criteria for Serving as an International Reserve Currency

Wednesday, September 23, 2009

The Criteria for Serving as an International Reserve Currency

The value of the dollar gets close scrutiny for, among other reasons, its role as an international reserve currency. A reserve currency is one that is held by countries and institutions as a store of value, for managing exchange rates, and for carrying out some international transactions.

Anders Aslund, a senior fellow at the Peterson Institute for International Economics, has a helpful article in today's Moscow Times that lays out the criteria a country must meet in order for its currency to challenge the dollar, the euro, the pound, and the yen for status as an international reserve currency.1 (Aslund's immediate reason for walking his reader through these criteria is to show that Russia's aspirations for making the ruble a reserve currency are pie in the sky for the foreseeable future.)

As Aslund explains, a reserve currency country must meet the following criteria. It must have:
  1. low inflation and a stable economy

  2. a large economy

  3. financial depth, i.e., large market capitalizaton (the total value of securities issued within its borders), substantial availability of securities for trade on the securities markets, and a non-politicized banking system

  4. a good regulatory framework and strong rule of law

  5. network externalities, "which include various international uses [for the country's currency], for example, for pricing, invoicing, or transactions outside the country"
Aslund concludes by noting the importance of "the power of incumbency," by which he means the self-reinforcing nature of choosing to invest funds in securities denominated in a reserve currency. These securities are favored because they are liquid, and, in turn, the purchasers they attract help maintain liquidity.

Aslund cites Barry Eichengreen, an economics and political science professor at Berkeley, as our leading scholar of reserve currencies. You can read some of Eichengreen's recent commentary on the international role of the dollar here.

1 Aslund reports, "In the last decade, the euro has emerged with 27 percent of global currency reserves, while the dollar still holds two-thirds. Sterling and yen account for 3 percent to 4 percent each, leaving less than 1 percent for other currencies."