Currency, like all forms of abstract value, is based on trust. And trust itself is based - except among the most naïve - on experience, and the repetitive demonstration of fidelity, whether positive or negative. At present, the US dollar, which had experienced a gradual rise during the 20th Century to the position gained well into the Cold War of being the trading world's reserve currency. It had the mass, in terms of volumes of available currency; it had the backing of an indisputably wealthy national asset base to move away from the gold standard; it had stable governmental backing.

All of that is evaporating. Not, in absolute terms, as far as the mass of currency available, because that has dramatically expanded in recent years, and particularly during the past year of the Administration of Pres. Barack Obama. Not in the underlying asset valuation of the US economy, but it has begun to erode as the productive capability of the US to extract that value diminishes due to excess governmental interference and anti-business practices. It is far to say that other countries, from Nigeria to Russia, have vast untapped underlying asset value. That they did not create global reserve currencies from their naira and ruble was due to governance failures.

However, as we are witnessing, good governance as an essential component of currency value and the trust in that currency, can transform overnight, just as we witnessed the post-World War II collapse of sterling, and, now, the shakiness of trust in the US dollar (despite the reality that, at $14.2-trillion in value in 2008, is the world's largest). The age of the US dollar as the global reserve currency is not yet over, but it is threatened, and the trend toward a flight from the dollar (despite occasional returns to it) is evident. At present, however, the dollar is shored up because in many respects there is nothing of its stature ready to replace it. This leads to the essential question:

Are we entering a period in which we may have no global reserve currency?

The People's Republic of China (PRC) has been searching for safe-havens for its holdings of foreign earnings. The US dollar has slipped in its esteem, with some short-term benefits, perhaps for US exports, but with perilous long-term consequences. As a result, and whilst attempting to preserve the intrinsic value of its currency holdings, the PRC has been gradually scaling back its holdings in US currencies or US dollar-denominated instruments.

Where can the PRC go with its hoard? It looked at euro investments, at Canadian and Australian dollar holdings, and so on. The Australian and Canadian economic bases -- at just under a trillion US dollar GDP for Australia, and about $1.4-trillion GDP for Canada -- are insufficiently large to hold much in the way of PRC investments. Nonetheless, these economies have benefited from the PRC dilemma. The euro, however, is, like the US dollar, suffering from a loss of credibility, and unless some profound action is taken the euro may dramatically diminish in credibility, severely hampering the loose confederal structure of the European Union, preventing it from becoming the federal state of Europe to which some (mostly unelected) aspire.

We are, then, faced with a situation in which we may find a world without a standby currency, when, for a period after World War II, it had a couple: the US dollar and the pound sterling. It could have had more -- the German mark and the Japanese yen -- of the parent states of those currencies had been in a position to build a global base of trust. Now we are left in territory unfamiliar to all those now living, other than for the interregna of the World Wars.

What are some options?

India, with a GDP equivalent to only about one-trillion US dollars (and how long will we use the US dollar as a global measure?) is not in the running. The PRC in 2007 already had a GDP of $3.2-trillion, and had, by that time done to India what India itself did in competitive terms to Pakistan over the past decade or so. The Indo-Pak strategic competition ended in India's economic triumph. The Indo-PRC strategic competition may well have also already been decided by the PRC's true "great leap forward": the one it took when it embraced capitalism and not the one avowed by Chairman Mao Zedong.

So can the PRC move toward creating the renminbi (Ren Min Bi: People's Currency, of which the yuan is the principal measure, such as the yen or dollar) as a global reserve currency?

Not yet. The PRC is hampered by a lack of transparent economic (and political) governance and a lack of market-determined tradability for its currency. And this in turn means that it has not yet, and cannot yet, gain global trust in its currency. That does not mean that it is not a tradable currency; it is, but with reservations.

The PRC, at present, cannot afford to move toward total economic or political transparency. It is a structure, arguably a mix between a federal and confederal and excessively centrist systems, which is in flux, much of it the flux of growth. This is inherently unstable, and the PRC leadership wisely will not tamper with the formula merely for the sake of providing the US with the economic satisfaction of lowering the exchange rate for the yuan or providing the world with the satisfaction of a new reserve trading currency.

The international community may be able to muster some credibility to resume greater reliance on the International Monetary Fund's Special Drawing Rights (SDRs), created in 1969 to reflect "baskets of currencies", but this mechanism of the Bretton Woods accords (which relied on fixed exchange-rate thinking and which, in any event, collapsed in 1973) remains clumsy. Still, SDRs continue to exist and may be the standby for a period. Some private institutions are also issuing trading certificates, but these would also take a lot of growth in backing and credibility to have any merit. And that leaves the old standby, gold, as a major standard of measure, albeit a difficult one. Physical trade in gold is not practicable for modern transaction scales; paper based on gold is, as yet, lacking in trust and a credible set of issuing authorities.

What this all means, in sum, is the prospect that major trade will gradually become more bilateral in nature, based on very real mutual trust in each other's currencies or goods. This will be a significant limiting factor in trade, and will make bilateral balances of greater interest than in the past when trade balances of a bilateral nature "washed out" in the great mixing bowl of the global banking system.

This situation, too, will severely impact investment in research and development of a global nature. It will, without doubt, also lead us back into an era of greater nationalism and national competition.

Source: Full article at: http://www.oilprice.com/article-the-search-for-a-reserve-currency-288.html

Analysis by Gregory R. Copley for Oilprice.com who focus on Fossil Fuels, Alternative Energy, Metals, Oil Prices and Geopolitics. To find out more visit their website at: http://www.oilprice.com