The Cost-benefit Analysis on International Reserve Currency Status: History from historical and theoretical perspectives Abstract: International reserve currency (IRC) is the highest form of currency internationalization. Based on general cost-benefit analysis on IRC, this paper explains the condition and influence to become a reserve currency from the perspective of the correlation with trade balance, the capacity of external financing and the autonomy of monetary policy respectively. In the final, we come to the conclusion that the cost and benefit of the IRCs are closely related to the currency’s international status. Classification exists in the structure of the international reserve currency system, which are center and sub-center. The core of currency internationalization is a natural selection process promoted by market forces. We also realize that whoever overtakes shall have complete knowledge of and sufficient patience in the currency internationalization Key Words: International reserve currency, cost-benefit, trade balance, external financing, autonomy of monetary policy —1— Chapter One: The General Cost-benefit Analysis on IRC Section One: Basic Concept and the composition of IRC I. Basic Concept In a narrow sense, IRC refers to the currency used for the means of international payment. In a boarder sense, it equals to the international currency. Generally, currency internationalization is regarded as the evolvement of currency function from trade valuation and settlement currency, investment and financing currency to reserve currency. Therefore, IRC is considered as the highest form of currency internationalization and the appearance of IRC greatly reduced the cost of economic transactions in the world. There only exists one currency in the ideal international currency system (ICS), however, it is just an ideal assumption (Wang Huaqing, 2010). In different stages of ICS, the category of reserve currency is somewhat different. In the gold standard system, currency in each country contains legal gold content and the gold coin has unlimited legal tender. Therefore, gold is a natural international reserves currency. The earliest typical gold standard or gold coin standard was put into practice in the UK. At that time, due to the status of the UK in the world economy system, London became the global financial center, and then both Sterling and gold were used as international reserve currency. In Bretton Woods System, US dollar pegged to gold turned into the center of ICS, and became the major reserve currency. In Jamaica System, the gold was demonetized, and IRC developed from monopolar pattern to diversification. In the following, US Dollar，Deutche Mark, Franc, Yen, new emerging Euro, and other fiduciary currencies are included in the IRC system. II. Main components of IRCs Since the establishment of Bretton Woods System，US dollar had become the center of ICS. Even after this system collapsed, US dollar remained the main currency used for international valuation, transaction and reserve. After the Euro emerged in the —2— world, depending on the comprehensive economic strength in Euro zone, the status of Euro in the IRC system went up steadily, and it became the second largest international reserve currency. The UK possessed a developed international financial market with history, and with the traditional advantages in the international business, Sterling still has a considerable influence. In addition, Yen, Australia Dollar, Swiss Franc and other currencies also play important roles in the IRC system. According to statistics made by International Monetary Fund (IMF), the total amount of international reserve currency sharply rises to USD11.6 trillion at the end of 2014 from USD 1.8 trillion at the turn of the century which has been increased by 5.4 times in the last fifteen years. The countries “producing” reserve currencies are different from the countries “consuming” reserve currencies. Most of the reserve currency in the world is held by emerging market and developing country. Foreign exchange reserve held by emerging markets and developing countries accounts for sixty percent of global foreign exchange reserves and this percentage basically has not been changed since the financial crisis in 2008. At the end of 2014, it reached 67%, increased by 32 points than that just before the Asian financial crisis in 1996. Emerging markets and developing countries holding so much foreign exchange reserve is the result of no alternative choices in the current ICS, known as the “original sin”. Many developing countries choose the export-oriented development pattern, as export and foreign direct investment have a remarkable impact on national economy. Holding considerable foreign exchange reserves not only is an inevitable result of accumulative trade surplus, but also to meet up with the potential demand to stabilize exchange rate and guarantee trade development (He Liping, 2008). Meanwhile, holding foreign exchange reserves is also a financial crisis prevention tool. Most developing countries experienced some period of foreign exchange shortage, and suffered from financial crisis, therefore, for them, holding foreign exchange reserves means a form of self insurance with defensive characteristics against speculative attacks from international capital (Heller，1996). Observing the global financial tsunami in 2008, although Russia, Korea and India and some other emerging markets experienced dramatic —3— exogenous shocks, large scale of capital outflow and sharp domestic currency depreciation, the large accumulation of foreign exchange reserve indeed played a role of “spare tire” to avoid financial crash and economic collapse (Guan Tao 2009). Figure 1: The Increase of Global Foreign Exchange Reserve (Unit: Hundred Million US Dollars) 140,000 D Hundred Million ollar 120,000 100,000 s Global Foreign Exchange 80,000 R全球外汇储备eserve 亿美元 60,000 US美元储备 dollar reserve 欧元储备 40,000 Euro reserve US US 20,000 0 Data sources: IMF. From above data, that main currency structure of IRC system is relatively stable. US dollar and Euro are the main reserve currencies. Meanwhile, the feature of US dollar being the single largest in the IRC system is obvious. At the end of 2014, the balance of global foreign exchange reserve is USD11.6 trillion, and among which, the composition of USD 6.1 trillion was disclosed with US dollar accounting for 62.9%, Euro accounting for 22.2%, Yen, Sterling, Canadian Dollar, Australian Dollar and Swiss Franc respectively accounting for 4.0%, 3.8%, 1.9%, 1.8%, 0.3%, and Other currency in total accounting for 3.1%. Figure 2: Main Currency Components in the International Reserve Currency (Unit: %) —4— 100% 90% Others 80% 70% EUR 60% AUD 50% CAD 40% CHF 30% JPY 20% 10% GBP 0% USD 2000 2002 2003 2005 2007 2009 2010 2012 2014 2001 2004 2006 2008 2011 2013 1999 Data sources: IMF. From this figure, we realize that the status of US dollar reserve currency is declining. The creation of Euro, a kind of super-sovereign currency, has been expected to shoulder the same international responsibility as US dollar does. In practice, the role of Euro on the IRC system is only second to US dollar. In addition, a tendency of “de- dollarization” appeared from the recent international financial crisis. This ideology is actively promoted by Russia and other emerging countries through trade settlement and payment system which further makes the status of US dollar, Euro and other reserve currencies decline. However, the powerful position of US dollar is difficult to be affected in the short term and international monetary system headed by US dollar shall not have disruptive change in the short period. Consequently, it is not pratical to expect super fast speed on the reform of ICS. The diversification of IRC is a long term process, and we may even say that there is no inevitable contradiction between that and US dollar still being leading role. (Zhou Xiaochuan, 2009; Guan Tao, 2014). Figure 3: Relative Decline of the Status on the US Dollar and Euro Reserve Currency (Unit: Hundred Million US Dollars; %) —5— 80.0 70,000 70.0 60,000 Total of disclosure currency on the global 60.0 foreign披露币种的全球外汇储备 exchange reserve (Hundred Million US Dollars, right axis) 50,000 US Hundred Million 合计（亿美元，右轴） 50.0 USD份额 % D USD share % 40,000 ollars 40.0 EUREUR 份额share % 30,000 30.0 20,000 20.0 10.0 10,000 0.0 0 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Data sources: IMF. Section Two: The benefits of international reserve currency for the issuers Different paths were taken to become main reserve currencies from historical view, as their status is the consequence of “system design” of ICS, with the inner tendency of self-reinforcement and to a great extent, it is also the result of market natural selection, with the comprehensive reflection of various advantage of reserve currency issuing countries. Reserve currency is able to bring some apparent and recognized benefits. I. Seigniorage refers to direct and measurable returns from reserve currency. In the context of fiduciary currency system, although Seigniorage has changed the traditional connotation, its existence is widely proven. The idea that Seigniorage shall be obtained by issuing countries of reserve currencies has been verified by Aliber （1964）, Cohen（1971）, Bergsten（1975）, Tavlas（1997）. It is measured by Chen Yulu.etc (2005) that from the establishment of Bretton Woods System to 2002, US dollar seigniorage approximately accumulates to a trillion US dollars, which equals to 0.66% of the United States’ GDP. Seigniorage from Yen approximately equals 0.46% of Japan’s GDP. As Quantitative Easing Policy is performed by many countries in the financial crisis, countries such as the U.S. also acquires higher earnings from —6— Seigniorage. II. Reserve currency is beneficial for the trade development of issuing country. For the main reserve currency, when domestic enterprise is conducting their international business, import and export is valued and settled by domestic currency.