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The World Reserve Currency and the Iranian Sanctions
Many Americans think the United States in invincible and regardless of how much money we spend, borrow, and print that there won’t be any drastic consequences. It’s as if they believe there is a magical power that protects the United States. As a matter of fact there is a name for this magical power of protection and it is called the world reserve currency.
History of the World Reserve Currency
After World War II, the United States dollar became the world’s reserve currency. Before this Britain with the pound sterling held the position as the world reserve currency for nearly all of the 19th century. Great Britain was the leading exporter of manufactured goods and services and the largest importer of food and industrial raw materials during this period. Between the early 1860s and the outbreak of World War I in 1914, some 60 percent of all the world’s trade was invoiced in British pounds sterling. As U.K. banks expanded their overseas business, propelled by innovations in communications technology such as the telegraph, the British Pound was increasingly used as a currency of denomination for commercial transactions between non-U.K. residents—that is, the pound sterling became a more international currency. This role for the pound was further enhanced by London’s emergence as the world’s leading shipper and insurer of traded goods and as a center for the organized commodities markets, as well as by the growing amount of British foreign investment, of which a large share was in the form of long-term securities denominated in pounds sterling. It was at the turn of 20th century that British influence began to deteriorate. Slowly the French Franc and German Mark began to be used as a reserve. However, the critical blow to Britain’s status as the world reserve currency occurred after World War II. Britain was devastated. They had taken out so many loans in order to finance their operations during the war that they were in horrible financial shape. It was at this point that the Bretton Woods agreement was formed and the US dollar, backed by gold, was used as the world reserve currency. The only major event that has taken place since then has been the dollar leaving the gold standard. So effectively now we have the dollar alone as the world reserve currency.
The Impact of the World Reserve Currency
What does the world reserve currency status effectively do for a country? It is interesting to look at the chart below. Every major country that has ever held the world’s reserve currency status has been a major player in world trade.
Effectively when a currency becomes the world reserve currency it means that most of the world uses that currency as the method of transaction between countries. As an example, if China wants to trade with Australia, today they will use the dollar instead if either the Chinese or Australian currency. The argument is that it is a fair way to use a good currency and a single currency in all international transactions. Consequentially, the world reserve currency, in this case the dollar, has a demand far beyond its own country and domestic use. It is used in both international trade and also held as a reserve by foreign countries. Today, China alone holds nearly $3 trillion dollars as a currency reserve.
The United States status as the world reserve currency has effectively allowed the manipulation of our currency and inflation to occur far beyond the normal and natural limits. It is interesting that Greece started to see their cost of debt rise once they crossed over the 100% debt to GDP mark. However, in the United States, we have seen no such problems as of yet. Effectively, the United States reserve currency status has given it an ace of spades so to speak when it comes to financial hardship.
The US Lose the World Reserve Currency?
It is important to realize that there is a dark cloud on the horizon for the United States. Every year there is a meeting of the top 20 economic super powers called the G-20 Summit. Over the last several years, multiple countries have suggested that the dollar no longer be used as the world reserve currency. Each year this party gains more and more traction. When the dollar loses its place as the world reserve currency, the dollar will plummet in value. Countries like China, Japan, and India who hold large amounts of dollars as reserves will dump them as fast as they can in order to either get the new world reserve currency or purchase hard assets like gold. In this event, Americans who hold most of their wealth in dollars or dollar denominated assets will get hit the hardest.
Iranian Sanction and the World Reserve Currency
So how is Iran significant? With both the United States and the EU putting sanctions on Iran and its central bank, Iran is caught between a rock and a hard place. Iran sells a massive amount of oil to India, China, and Japan. India and China together account for over 34 percent of Iran’s oil exports — slightly more than Europe, according to International Energy Agency data. India has defied the sanctions and has continued to purchase oil with gold instead of dollars. Therefore India has technically avoided violating the sanctions. This means billions of dollars in oil will no longer be purchased in dollars, but will purchased using gold or another currency. This is the first effective challenge to the United States as the world reserve currency. As the crisis develops it will be very important to watch how many countries continue to purchase oil from Iran in spite of the sanctions. It will also be interesting to see whether the United States goes to war with Iran. Every nation that has begun to not accept dollars for oil in the past have eventually been taken out.(Iraq and Libya)
