by Bill O’Grady
In Part 1 of this report, we discussed how the reserve currency facilitates trade, provided a short history of the dollar’s evolution as the reserve currency and examined the theoretical backdrop of the reserve currency and its role as a global public good.
In this week’s report, we will conclude with the economics and geopolitics of the reserve currency and discuss potential market ramifications.
The Economics of the Reserve Currency
When the U.S. accepted the reserve currency role in 1944, the U.S. economy dwarfed the rest of the world. However, the relative size of the American economy has declined, in part due to the success of U.S. policy in rebuilding the free world after WWII. This situation accelerated with the development of China. On a purchasing power parity basis, the U.S. is currently the second largest economy in the world, with China being the largest.