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The following guest post is courtesy of Emma Davidson, Communications Manager at FXTM.
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Global currency revaluation is a divisive topic, writes FXTM’s Emma Davidson. It has been covered extensively by experts purporting it will never happen, and others who decry that it is inevitable. So, which camp has it right?
A global currency re-evaluation would require all nations – or the vast majority of them – to agree to one currency standard, for example, returning to the gold standard. However, a reset will likely take some kind of apocalyptic calamity to trigger mass acceptance by governments and their citizens, or at least give the movement more gravity than it currently has.
The last time world powers agreed on the standardisation of currencies was after the Second World War; when everyone feared a repeat of the Great Depression of 1930. The Bretton Woods agreement resulted in the world’s allied nations agreeing to a fixed international gold standard attached to the U.S. dollar. It essentially created a ‘pegged rate’ currency regime. Members established the parity of their national currencies in terms of gold and were required to maintain exchange rates within a 1% band of parity. They would maintain this by intervening in their foreign exchange markets, i.e. buying or selling foreign money.
Since the principal reserve currency was the U.S. dollar, countries would peg their currencies to the U.S. dollar, and once convertibility was restored, they would buy and sell U.S. dollars to keep market exchange rates within the agreed parity band. This resulted in the U.S. dollar taking over the role that gold had played under the gold standard in the international financial system.
The Bretton Woods system was, for all intents and purposes, a massive financial experiment, and many predicted its failure. By 1973, those predictions were realised. The termination of convertibility of the US dollar to gold by the Nixon administration eventually caused the demise of the Bretton Woods Agreement and subsequently, a number of currencies began to be freely determined by market forces, a system those familiar with currency trading will recognise. The debate regarding the relative merits of fixed versus floating exchange rates continues to dominate discussions in international monetary policy.
The 2008 economic crisis has precipitated some major rethinks on how to curb currency volatility. An overarching global currency revaluation would require an epic amount of cooperation between nations which would ostensibly amount to them having to surrender control of their monetary policy – this is a huge ask and would require a massive leap of faith in the architects of such a plan.
A global currency revaluation would also require central banks to accept limitations on their ability to conduct monetary policy. Given the distrust that currently exists amongst the major economies, the chances of them relinquishing control of monetary policy are slim to none.
Plus, they would need to agree on a new currency standard. The Chinese are strong advocates of adopting Special Drawing Rights (SDRs) as an alternative reserve currency. SDRs were created back in the late 60’s as an emergency response to the pending U.S. dollar crisis, caused by Nixon’s administration abandoning the gold standard. SDR’s are a weighted “basket” of currencies (consisting of the USD, the Euro, the British Pound, the Japanese Yen and the Chinese RMB) bundled together into one SDR unit. The SDR currency value is updated daily and can be seen on the IMF’s website. The Chinese RMB has only recently been added to the SDR basket, which might explain their interest in it becoming a reserve currency.
But SDRs lack the liquidity to operate as an effective reserve – at least for the moment – and there are insufficient SDRs in circulation for it to support the requirements of international monetary finance. Many experts are putting their bets on the Chinese renminbi becoming the next reserve currency. While it still has limitations in terms of its tradability, experts agree that it’s a serious contender. There remain some questions around the real growth rate of China, but there is no doubt that it is a growing economy that is likely to outpace Western counterparts in the next 20 years. In purely economic terms, it makes sense to transact more in this currency, something those with experience of forex trading know only too well.
Is a global currency reset inevitable? The jury is still out, but one thing is for certain, disruption is happening and we are in for some exciting times.
Disclaimer: The content in this article comprises personal opinions and ideas and should not be construed as containing personal and/or other investment advice and/or an offer of and/or solicitation for any transactions in financial instruments and/or a guarantee and/or prediction of future performance. FXTM, its affiliates, agents, directors, officers or employees do not guarantee the accuracy, validity, timeliness or completeness of any information or data made available and assume no liability as to any loss arising from any investment based on the same.
Risk Warning: There is a high level of risk involved with trading leveraged products such as forex and CFDs. You should not risk more than you can afford to lose, it is possible that you may lose more than your initial investment. You should not trade unless you fully understand the true extent of your exposure to the risk of loss. When trading, you must always take into consideration your level of experience. If the risks involved seem unclear to you, please seek independent financial advice.
NOTES TO EDITORS
The FXTM brand provides international brokerage services and gives access to the global currency markets, offering trading in forex, precious metals, Share CFDs, ETF CFDs and CFDs on Commodity Futures. Trading is available via the MT4 and MT5 platforms with spreads starting from just 1.3 on Standard trading accounts and from 0.1 on ECN trading accounts. Bespoke trading support and services are provided based on each client’s needs and ambitions – from novices, to experienced traders and institutional investors. ForexTime Limited is regulated by the Cyprus Securities and Exchange Commission (CySEC), with license number 185/12, licensed by the SA FSB with FSP number 46614, and registered with the UK FCA under reference number 600475. FT Global Limited is regulated by the International Financial Services Commission (IFSC) with license numbers IFSC/60/345/TS and IFSC/60/345/APM.