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Cyprus has put in place draconian regulations to prevent the flight of euros from its banks. But at an alititude far above the little island, central banks in emerging market countries are shedding euros and buying other currencies. The parts of the world that are growing fastest have been shrinking their euro reserves over the past year, reflecting weaker expectation that Europe's single currency will ever challenge the U.S. dollar as the favoured foreign exchange reserve.
Over the past year, according to IMF statistics, central banks among the emerging market nations and the developing world generally have sold €45-billion ($58.7-billion), reducing their euro holdings by 6 per cent. Since June 2011, the share of euros in their forex reserves has shrunk by 12 per cent. They have switched into dollars, bolstering America's status as home of the most reliable currency in which to do business, and they have bought Japanese Yen and Swiss Francs, too.
They are also investing in each other's currencies. China is seeking to boost the status of its own currency, the renminbi, encouraging the offshore renminbi bond market in Hong Kong, available to foreign investors. At last week's BRICs summit, China signed a currency swap agreement worth $30-billion with Brazil. The two nations are major trading partners, swapping Brazilian iron ore and farm produce in favour of Chinese manufactured goods. The currency swap will enable each nation to borrow in the other 's currency when credit runs dry in international lending markets, as it did during the 2008 financial crisis, ensuring trade continues. China has a similar agreement with Australia, another important raw material supplier.
These deals beg the question whether the euro will ever achieve the reserve status of the dollar, or whether it will be surpassed by an emerging market currency such as the renminbi. The Chinese currency has a long way to go, not being fully convertible, and the euro has the scale of the euro zone economies to ensure it continues to represent a large proportion of the reserves of any large trading nation. Set against the euro is the insecurity now afflicting its weaker sovereign bond markets and the rising importance of trade among developing nations.
We are likely to see more currency deals such as those agreed by China. As the Asian giant matures into a consuming nation, its regional trade is likely to expand, such that its currency might challenge the status of the Japanese Yen. We may see local currency champions where regional trade between expanding emerging market nations is conducted through the currency of the dominant regional player. The U.S. dollar's status in those markets will remain important but diminished. In such a world, the dollar remains top of the pile but within each continent there is a BRIC currency that has the strength and liquidity to grease the wheels of regional trade.
Carl Mortished is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here for more of his Insights.
Carl Mortished