Increased demand for dollar assets lowers their return, creating an incentive for firms to borrow in dollars. The liquidity and safety properties encourage this further.15 In turn, companies with dollar-denominated liabilities have an incentive to invoice in dollars, to reduce the currency mismatch between their revenues and liabilities. More dollar issuance by non-financial companies and more dollar funding for local banks makes it wise for central banks to accumulate some dollar reserves. Given the widespread dominance of the dollar in cross border claims, it is not surprising that developments in the US economy, by affecting the dollar exchange rate, can have large spillover effects to the rest of the world via asset markets. As Hélène Rey has put it,16 and as Arvind Krisnamurthy and Hanno Lustig echo in their paper for this symposium, the global financial cycle is a dollar cycle. In part, that arises because movements in the US dollar significantly affect the real burden of debt for those companies (especially in EMEs) that have borrowed unhedged in dollars, and tend to reduce the dollar value of companies’ collateral.17 Both result in tighter credit conditions and, in the extreme, defaults. Fluctuations in the dollar also significantly affect the risk appetite of global investors. As discussed by Şebnem Kalemli-Özcan earlier today, these risk spillovers can have a significant impact on receiving economies, especially in EMEs where global risk perceptions interact with country-specific risks.
That won’t be easy. Transitions between global reserve currencies are rare events given the strong complementarities between the international functions of money, which serve to reinforce the position of the dominant currency. And the most likely candidate for true reserve currency status, the Renminbi (RMB), has a long way to go before it is ready to assume the mantle. The initial building blocks are there. Already, China is the world’s leading trading nation, overtaking the US at the start of this decade.34 And the Renminbi is now more common than sterling in oil future benchmarks, despite having no share in the market prior to 2018.35 The greater use of the Renminbi in international trade is also leading to its growing use in international finance. This has been enabled by reforms to China’s monetary, foreign exchange, and financial systems that have liberalised and improve its financial market infrastructure, making the Renminbi a more reliable store of value.36 The Belt and Road Initiative could foster further take up of the Renminbi in both trade and finance. However, for the Renminbi to become a truly global currency, much more is required. Moreover, history teaches that the transition to a new global reserve currency may not proceed smoothly.