October 19, 2015

Re-examing the fall of the British pound and the decades with two reserve currencies

Economic historians have re-examined sterling’s (UK pounds) downfall, in search of clues about how the impending tussle between the dollar and the yuan might unfold. The research yields lessons in three broad areas—how a currency attains reserve status, whether a two-currency system is possible, and how poor policymaking can speed a currency’s decline.

The pound dominated the financial world in the late 19th century: more than 60% of trade and 90% of public-debt issuance around the world was conducted in sterling. In part, this was owing to sheer economic clout: at its zenith, the British empire encompassed nearly a quarter of the world’s people and territory. But as a recent series of papers by Barry Eichengreen of the University of California, Berkeley, and several colleagues shows, this was not a sufficient condition for financial hegemony. After all, America’s economy overtook Britain’s in size around 1880, yet the dollar was rarely used abroad until after the first world war.

Mr Eichengreen argues that the “size, stability and liquidity” of financial markets are the most important determinants of reserve status.

The dollar only began to supplant the pound after the establishment of the Federal Reserve in 1913, which helped make America’s financial markets both more liquid and more stable

Two reserve currencies can co-exist for a long period. Although the dollar began gaining ground in the aftermath of the first world war, the pound remained an equally significant reserve currency throughout the interwar period. Nor is the road to a new reserve currency a one-way street: sterling regained some ground when America was hit by a series of banking crises in the early 1930s.






SOURCE - Economist

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