THE RISE, REIGN, AND FALL OF DOMINANT RESERVE CURRENCY EMPIRES

Abstract

The internationalization of the Yuan, recently pursued by the CCP, has spurred much speculation on whether the Yuan can displace the USD as the dominant currency. This is ever so more threatening because China is projected to surpass the US economically, politically, socially, and internationally in the foreseeable future. To contribute to the literature on reserve currencies and the overall trajectory of Sino-US competition, this thesis investigates the process of dominant reserve currencies’ life cycle. In other words, under what conditions do a dominant reserve currency rise, reign, and eventually fall? By answering this question, we are one step closer to answering whether the Yuan has the potential to displace the USD. To do so, first, a framework consisting of four elements is created: military capacity, the share of world trade, currency volatility, and performance in financial and external shocks. Each element is tied to a condition and two sets of conditions were created for ‘rising’ and ‘falling’ currencies. This research hypothesizes that the four elements demonstrate a specific correlation between the outcome of a currency and the number of elements satisfied.

The framework is tested on four historical cases, two successful and two non-successful: the Dutch Florin to the Pound Sterling, the Pound Sterling to the US Dollar, the failure of the Japanese Yen to the US Dollar, and the incapability of the Euro to displace the US Dollar. The results of the four case studies show a correlation between the number of elements satisfied and the outcome of the currency. Currencies that satisfied all the ‘rising’ conditions within the framework became dominant reserve currencies while currencies that did not satisfy all the conditions could not rise to become the dominant reserve currency. As for the downfall of currencies, currencies that fulfilled all the conditions for a ‘falling currency’ lost their status as the dominant reserve currency.

Using the same framework, the conditions are applied to the Yuan and USD. The results show that, if current conditions and trajectory persist, the Yuan is on the path to displacing the USD as the dominant reserve currency. Moreover, beyond the framework, China also exhibits many conditions favorable to the Yuan’s rise.