Lisa Simpson
Aug 31,2009
In: Finance

There Are Good Reasons Behind a Country Wanting Its Currency to the International Reserve

Basically there are two reasons behind a country wanting its currency to be the international reserve. Firstly is the issue of seigniorage. It means the country issuing the currency is in reality borrowing without paying interest. All the central banks earn this seigniorage from issue of currency. In essence it is the citizens who are paying the premium to the central bank for the protection of the currency of the country.

Hence the country that is in charge of issuing the global reserve currency benefits from seigniorage from the foreigners who have this currency. The amount can sometimes be staggering. USA today holds that enviable position and is reluctant to give up that position despite outside pressure from China and India after the crisis that has hit USA and the world.
The second benefit is much larger – it relates to trade and commercial services. When Britannica ruled the waves London benefited from the sterling – it being the trading hub for goods, loans and related commercial and legal activities. After World War II the sterling lost its position to the American dollar. But London continued to remain the centre for the Euro-dollar market complementing New York in Europe. The jumbo banks, fund managers, brokers and insurance companies operate simultaneously from both London and New York because of sharing common language, law and business rules.
What makes a place to qualify to be an international financial centre? Basically there are three requisites – protection of property rights, comparatively low transaction costs and high levels of transparency.

Western economists comment that London and New York enjoy the best property rights because of accepted law and fair judiciary. But property right protection is something beyond mere laws and its enforcement. It also means political stability, the absence of any talk about nationalization, fears of imposition of predatory taxes and looming military presence. No global financial centre can operate under war conditions or a banana republic.
Secondly no financial centre can function with success without excellent communication system – top class telecommunication and transport as well as A-grade living conditions. Geography too is a factor. New York dominates the time zone of America while London that of Europe and Africa.
Thirdly comes the point of transparency because markets rely on information that has to be accurate, timely and easily accessible. It is with these tools that investors will be able to know, operate and thrive in the world of finances.