Unformatted text preview: , the dilemma was whether or not to increase the interest rate to break
the stock market bubble, and restore capital outflows. However, such a step restricted
business credit. For China, the dilemma is how to reduce its holdings of US securities without
sparking any panic in the exchange market which may eventually lead to a dramatic
depreciation in dollar.
Cooperation with Other Central Banks: Dollar’s success in replacing pound as the
reserving currency is also attributed to the Fed’s ability to frequently cooperate with other
central banks, particularly the Bank of England. In any such cooperation, the US used to have
an upper hand because of its significant gold reserves and dominant economy. However,
given the differences in political institutions, languages and cultures of China and the US, any
serious cooperation between the People's Bank of China and the Fed is doubtful. External Environment
A Weak Major Reserve Currency: After the WWI, the pound was weakened. This made
the promotion of the dollar easier. China is also facing a weak reserve currency (dollar) now.
This weakness was also realised way back in 1960s, as a result of which the world started to
look for its substitute.
Different International Monetary System: In the 1920’s, the monetary system comprised
of the gold standard and fixed exchange rates. Gold played a crucial role of being an
intermediary during the transition from the pound to the dollar. In the gold standard system, it
was possible to convert the pound reserves outside Britain into gold. When the pound faced
massive demand for converting into gold, the pound moved off gold in 1930. As a result, the
reserve holders who still had pounds suffered significant losses.
The current monetary system is not based on gold standard. In the transition from the dollar
to the Yuan, the prime issue is to prevent losses to the dollar reserve holders. If the dollarYuan transition starts looking imminent, the value of the dollar will tank and the value of the
Yuan zooms. Any such event will also hurt China as it holds the biggest dollar reserves.
Competitors: The US did not face any competition while it promoted the dollar as the next
reserve currency in the 1920s. But today, the Yuan faces competition from different corners.
The Euro leads the pack of competing reserve currencies in the world with a c.15.3% share of
the world foreign reserves in 2009. SDR, the Japanese Yen and the Russian Ruble are also
the likely candidates that may replace dollar. Economic Crisis: In the late 1920s, the world was affected by the Great Depression. Before
this crisis, the pound was weakened, and the US had accumulated huge reserves of the pound
in order to replace it. During 2008-09, the world has faced one of the most severe financial
and economic crises ever. Before this crisis, the dollar was weak and China had accumulated
it by purchasing the US securities. Although the story is similar till now, the d...
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This document was uploaded on 01/14/2014.
- Winter '14