The US Dollar'S "Incumbent" Advantage Has The Greatest Potential. The Challenger Will Be RMB.

The US dollar will maintain its dominant international currency position in the foreseeable future.

Although the euro denominated assets have significantly improved in liquidity and depth after the establishment of the euro zone, the "incumbent advantage" of the US dollar is insurmountable.

The most potential challenger for the US dollar will be RMB or Asian Currency Unit with RMB as its core.

But the prerequisite is that Asia can vigorously develop its financial market.

We still believe that in the foreseeable future, the US dollar will maintain its dominant reserve currency status.

Next, we will answer questions that some readers may be interested in in the form of questions and answers.

Question 1: are central banks in various countries rapidly reducing their holdings of US dollar assets and diversifying their investments?

There are different ways of thinking about this problem.

The most cited data are IMF's official foreign exchange reserve structure (COFER).

First of all, it should be noted that not all IMF member states also report their currency structure while reporting their total reserve positions.

For example, at the end of 2007, COFER data covered only 64% of the world's reserves.

According to COFER data, the share of the US dollar in global foreign exchange reserves has decreased from 72.7% in 2001 to 63.9% at the end of 2007, accounting for 69.4% of the developed countries (60.7%).

In the same period, the share of the euro rose from 17.6% to 26.5%, while the euro area's openness of developing countries (29%) was higher than that of developed countries (22.2%).

Thus, the short answer to the first question is "yes". In the past few years, the share of the US dollar in the official reserves of the world has indeed declined.

However, the answer is brief but not comprehensive.

First, we must consider the possible impact of exchange rate fluctuations on the relative share of currencies in order to arrive at the conclusion that central banks are already reducing the US dollar.

According to IMF's annual data on reserves and currency movements in different currencies, we find that, in general, central banks actually bought dollars in an unusual proportion in the years of depreciation of the dollar (2002 and 2005 were exceptionally because of the appreciation of the US dollar over the past two years), and the euro was purchased at an unusual rate in the year of euro depreciation (2005).

In other words, central banks are in "low absorption and high dumping" to ensure the benchmark target.

The decline in the US dollar share is mainly due to the weakness of the US dollar. Similarly, when the dollar was strong in 2002, the share was higher.

Second, although the share of 63.9% is low, at least it is lower than 72.7% in 2001, but in the early 1990s, the share of the US dollar actually slipped below 50%.

Therefore, from a long-term perspective, the reduction of US dollar share is not a worry at all.

Question 2: will the euro challenge the dominant reserve currency status of the US dollar?

The answer to this question is not as straightforward as straightforward.

There are several considerations in this question.

Some scholarly books, when discussing this subject, use quantitative methods to calculate the currency share of official reserves based on some basic variables, such as the size of the economy, the rate of return and the liquidity of the reserve currency in the financial market.

According to these indicators, the euro seems to pose a severe challenge to the US dollar.

In addition, if the UK joins the euro zone, many of the euro area's liquidity and market size indexes will likely exceed that of the US capital market.

For example, the total market value of bonds and securities in the euro zone and Britain in 2007 was $374 trillion, equivalent to 30% in the world; the same index in the United States was $435 trillion, accounting for 35%, and the difference between the two sides was not much.

Despite the above view, there are two reasons why we believe that the euro can not replace the US dollar as the dominant reserve currency, though it can share some market share from the US dollar.

(it's like a racing car. It's not difficult to catch up with the car ahead. It's another thing to overtake it.)

The primary advantage of the US dollar is that it is "the incumbent".

Scale increasing efficiency is very powerful.

We can make analogy between competition between languages. English is the dominant international language, not necessarily because of its inherent superiority to other languages, but because it is already the "leader" and is the most widely used foreign language in the world, so it is likely to keep leading, because people around the world learn English in order to communicate with other countries.

To overcome the "incumbent advantage" of the US dollar, other currencies must have many advantages over the US dollar.

Historically, the US economy and trade strength had surpassed Britain in the early 1920s, but the US dollar instead of sterling has become the dominant international currency, and only in 1940s.

If anyone says this time the dollar's decline will not take so long, our view is that even if the euro countries surpass the United States in the economic and asset markets, they will hardly be as large as the United States over Britain.

The second consideration is related to the first one, that is, the real problem is not simply comparing the US and the euro area who are stronger.

We should actually ask which monetary standard the rest of the world (which has not yet established a reserve currency) will adopt.

Especially in Asia, it seems to us that the dollar standard is more likely to persist over a long period of time.

Even though Asian currencies are rarely pegged to the US dollar, international pactions in Asian countries and regions are still paid in US dollars. This reflects the fact that most currencies are not fully convertible. It also reflects the trade and trade between Asian countries and regions. Their invoicing and settlement prefer US dollars rather than Asia's own currencies.

We can also hear this saying that Asia's trade with Europe is at least as great as that of Asia's trade with the United States.

This view is pointless, because intra Asian trade is carried out in US dollars, and 43% of Asian trade is intra Asian trade.

Question 3: will the renminbi become a challenger to the dollar someday?

Within a generation, the size of China's economy exceeds that of the United States.