Here’s How Reserve Currencies Have Evolved Over 120 Years

Over the last 120 years, the popularity of different reserve currencies have ebbed and flowed, reflecting the shifting fortunes of leading global economies.

For example, in the year 1900, the U.S. dollar and pound sterling made up 0% and 62% of global reserves respectively. But fast forward to 2020, and the pound now represents just 4.7% of global currency reserves, while the U.S. dollar stands at nearly 60%.

Today’s motion graphic from James Eagle looks at the year-over-year change in currency reserves as a portion of total reserves, spread across 120 years.

What is a Reserve Currency?

A reserve currency is a large quantity of currency held in “reserve” by monetary authorities like central banks.

Currencies are often held in reserve in preparation for investments and transactions, among other things. Our vast global trade system, which is approaching $20 trillion in value, means plenty of currencies are always needed in reserve. In fact, an estimated $5 trillion in currency swaps hands every single day.

Here are some reasons that currency reserves are held:

• Exchange rate stability for the domestic currency
• To ensures liquidity in times of crisis
• To diversify central bank portfolios, which can reduce risk and improve credit ratings

All things equal, countries benefit economically from greater demand for their respective currencies.

The Rise and Fall of Reserve Currencies

Some economists argue that the demand for currencies in the long run revolves around the economic relevance of a country. In general, the larger and more powerful a nation’s economy is, the greater the network effect, and the more interlinked they are to the global economy. Thus, the greater demand there is to hold their currency in reserve.

The last 120 years of currency reserve data shows some support for this claim. For example, Japan’s economy hit a peak in terms of its relative share of global GDP in the early 1990s, just before the effects of the Lost Decade were felt. Subsequently, their peak as a reserve currency was around the same horizon, at 9.4% in 1990.

America’s Era of Dominance

Due to the economic strength of the United States in the post-WWII era, the dollar is what economists call a vehicle currency.

This means many non-dollar economies still choose to engage in international transactions using the dollar. These smaller and less accepted currencies are often converted to U.S. dollars before proceeding with any business or trade dealings. This is why, although Asian economies tend to have neighboring states as their top trade partners, they still engage in a massive portion of these transactions with the U.S. greenback as the currency of choice.

Here are some facts that further exemplify the strength and power of the U.S. dollar:

• More than 65 countries peg their currencies to the U.S. dollar
• Five U.S. territories and a number of sovereign countries, such as Ecuador and Panama, use it as an official currency of exchange
• Around 90% of all Forex trading involves the U.S. dollar

Additionally, the dollar is often seen as a haven in times of extreme uncertainty and tumult. Given its status as the world’s reserve currency, it can be perceived as less risky and can withstand economic shock to a greater degree relative to other currencies.

New Challengers to the Dollar

In the not too distant past, the U.S. displaced the UK economically and as the world’s reserve currency. Today, the U.S. economy is showing signs of slowing down, based on GDP growth.

China is on the rise, having already displaced the U.S. as the EU’s top trade partner. With projections for China to overtake the U.S. as the world’s largest economy before 2030 in nominal terms, could a new global reserve currency emerge?

Tweet
Share
Share
Reddit
Email

The world is in the midst of a notable period of demographic transition.

Back in the 1960s, global population growth peaked at a 2.1% annual rate, but since then it has been on a historic downtrend.

In fact, according to the most commonly cited United Nations projection, which is based on a medium fertility rate scenario, it’s expected that annual population growth could drop all the way to 0.1% by the end of the 21st century.

Visualizing a Demographic Transition

Today’s powerful charts come from Our World in Data by economist Max Roser, and they show how global demographics will shift over the next 80 years.

Below you can see one major catalyst of this change, which is the peaking (and then falling) population growth rate:

Why has population growth been dropping since the 1960s?

A variety of explanations factor into this, including:

• Falling fertility rates:
  Birth rates tend to fall as nations get richer. First, this happened in the developed world, but as the century progresses this phenomenon will impact more and more developing nations.
• Government policy:
  China’s “One Child Policy” in particular had an effect on global population growth, and the aftermath of the policy is still contributing to a shrinking Chinese population over the long term.
• Rural flight
  Urban dwellers tend to have fewer babies—and by 2050, there will be an additional 2.5 billion people living in cities globally.

Fewer births combined with improving healthcare—especially in developing nations—will dramatically alter the composition of the world population pyramid, creating both economic opportunities and challenges in the process.

The Changing World Population Pyramid

The following graphic charts how these changes affect the makeup of the world’s population.

Over time, the shape of the world population pyramid is expected to shift from Stage 1 (high birth rates, high death rates) to something closer to Stage 4 (low birth rates, low death rates).

As the population distribution skews older, here is how population size and global median age will change:

Global median age is projected to surpass 40 years by the end of the century, and it will be considerably higher in many Western nations, especially in Japan and Europe.

With the future demographic composition looking very different than today, it will be fascinating to see how the economy responds to these potential tailwinds. Further, it will be even more interesting to see what role automation will play as the old-age dependency ratio hits historic highs.