Lame Ducks in Love

Just as the US recently pressed European leaders to rescue the euro, owing to fears that a collapse could weaken the dollar, so American policy makers in the 1960's sought to prop up that era's second-leading international reserve currency, the British pound. With the renminbi as a reserve option, the euro and the dollar would be freed from their forced marriage.

FLORENCE – Fears about sovereign debt and doubts about the euro rescue package have pushed the question of international reserve currencies to the fore. Until this spring, most observers had assumed that the share of the dollar in international reserves would gradually fall, while that of the euro would rise, and that the world would gradually and smoothly make a transition to a multi-reserve regime.

Up to now, the global financial crisis was historically remarkable in having no major impact on foreign-exchange markets. The shares of the major reserve currencies were stable, with the dollar accounting for 62% of foreign-exchange reserves in 2009 and the euro 27%. Any major changes came not from deliberate decisions by central banks to reallocate reserves, but rather from the simple arithmetic of changing exchange rates: a stronger dollar raised the dollar’s share in total global reserves, while a weaker dollar reduced it.

In fact, a sort of balance of terror obstructed any major reallocations by the big holders of reserves. An effort to diversify by selling a particular asset would have such a large impact on markets that it would produce large losses for any central bank that tried it.

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