"The Financial System Is Vulnerable," NYFed Asks "Could The Dollar Lose Its Reserve Status?"

Tyler Durden's picture

When a tin-foil-hat-wearing blog full of digital dickweeds suggest the dollar's reserve currency status is at best diminishing, it is fobbed off as yet another conspiracy theory (yet to be proved conspiracy fact) too horrible to imagine for the status quo huggers. But when the VP of Research at the New York Fed asks "Could the dollar lose its status as the key international currency for international trade and international financial transactions," and further is unable to say why not, it is perhaps worth considering the principal contributing factors she warns of.


Via The World Economic Forum blog,

Could the dollar lose its status as the key international currency for international trade and international financial transactions, and if so, what would be the principal contributing factors?

Speculation about this issue has long been abundant, and views diverse. After the introduction of the euro, there was much public debate about the euro displacing the dollar (Frankel 2008). The monitoring and analysis included in the ECB’s reports on “The International Role of the Euro” (e.g. ECB 2013) show that the international use of the euro mainly progressed in the years prior to 2004, and that it has largely stalled since then. More recently, the euro has been displaced by the renminbi as the debate’s main contender for reducing the international role of the dollar (Frankel 2011).

This debate has mainly argued in terms of ‘traditional’ determinants of international currency status, such as country size, economic stability, openness to trade and capital flows and the depth and liquidity of financial markets (Portes and Rey 1998). Considerations regarding the strength of country institutions have more recently been added to the list. All of these factors influence the ability of currencies to function as stores of value, to support liquidity, and to be accepted for international payments. Inertia also plays a role (e.g. Krugman 1984, Goldberg 2010), raising the bar for currencies that might uproot the status quo.

We argue here – building on discussions we began during the World Economic Forum Summit on the Global Agenda 2013 – that the rise in global financial-market integration implies an even broader set of drivers of the future roles of international currencies. In particular, we maintain that the set of drivers should include the institutional and regulatory frameworks for financial stability.

The emphasis on financial stability is linked with the expanded awareness of governments and international investors of the importance of safety and liquidity of related reserve assets. For a currency to have international reserve status, the related assets must be useable with minimal transaction-price impact, and have relatively stable values in times of stress. If the risk of banking stress or failures is substantial, and the potential fiscal consequences are sizeable, the safety of sovereign assets is compromised exactly at times of financial stress, through the contingent fiscal liabilities related to systemic banking crises. Monies with reserve-currency status therefore need to be ones with low probabilities of twin sovereign and financial crises. Financial stability reforms can – alongside fiscal prudence – help protect the safety and liquidity of sovereign assets, and can hence play a crucial role for reserve-currency status.

The broader emphasis on financial stability also derives indirectly from the expanded awareness in the international community of the occasionally disruptive international spillovers of centre-country funding shocks (Rey 2013). We argue that regulatory reforms can play a role in influencing these spillovers. Resilience-enhancing financial regulation of global banks can help reduce the volatility of capital flows that are intermediated through such banks.

On financial stability and reserve-currency status

International reserve assets tend to be provided by sovereigns, notably due to the fiscal capacity of the state and the credibility of the lender of last resort function of the central bank during liquidity crises (see also De Grauwe 2011 and Gourinchas and Jeanne 2012). Systemic financial events can be accompanied by pressures on the government budget, however. While provision of a fiscal backstop to the banking sector is not the best ex ante approach to policy, fiscal support will tend to be forthcoming if the risk and estimated welfare costs of a systemic fallout are otherwise deemed too high.

Yet banking sector risks – and inadequate capacity within the banking sector to absorb these risks – can end up exceeding a government’s ability to provide a credible fiscal backstop without adversely affecting the safety of its sovereign assets. The fiscal consequences of bailouts may result in increased sovereign risk and the loss of safe-asset status, with implications for the status of the currency in question in the international monetary system.

To increase the likelihood that sovereign assets remain safe during systemic events, the sovereign can undertake financial and fiscal reforms that decouple the fiscal state of the sovereign from banking crises. Such reforms should achieve, in part, a reduction in the likelihood of and need for bailouts through increased resilience and loss absorption capacity of the financial system, and by ensuring sufficient fiscal space for credible financial-sector support (see also Obstfeld 2013).

Reform initiatives

A number of current reform initiatives already take steps in this direction. These include:

  • Reforms to bank capital and liquidity regulation, which reduce the likelihood that financial institutions, and notably systemically important ones (SIFIs), become distressed;
  • Initiatives that seek to counteract the procyclicality of leverage, and to strengthen oversight; and
  • Recovery and resolution regimes for distressed systemically important financial institutions (SIFIs) are being improved.

Importantly, initiatives are underway to improve recovery and resolution in the international context. While a global agreement on cross-border bank resolution is currently not in place, bilateral agreements among some pairs of countries are being forged ex ante to facilitate lower-cost resolution ex post. Further, the resilience of the system as a whole is being strengthened, to better contain the systemic externalities of funding shocks. Examples include:

  • The strengthening of the resilience of central counterparties and other financial market infrastructures; and
  • The foreign currency swap arrangements among central banks to provide access to foreign currency funding liquidity at times when market prices of such liquidity are punishingly high.

Nevertheless, the financial system contains vulnerabilities – globally, as well as in individual currency areas. The negative sovereign banking feedback loop may be weakened in many countries, but has not been fully severed. Moreover, reforms are not necessarily evenly implemented across countries. Fiscal capacities to provide credible backstops of the financial sector during stress vary widely. The consequences of recent reforms for the future of key international currencies are therefore open. Scope remains for countries vying for reserve-currency status to use the tool of financial stability reform to protect the safety and liquidity of their sovereign assets from the contingent liabilities of financial systemic risk.

Financial stability reforms matter for spillovers and capital flows

International capital flows yield many advantages to home and host countries alike. Yet the international monetary system still faces potential challenges stemming from unanticipated volatility in flows, as well as occasionally disruptive spillovers of shocks in centre-country funding conditions to the periphery. With the events around the collapse of Lehman Brothers, disruption in dollar-denominated wholesale funding markets led to retrenchment of international lending activities. Capital flows to some emerging-market economies then recovered with a vengeance as investors searched for yield outside the countries central to the international monetary system, where interest rates were maintained at the zero lower bound. After emerging markets were buoyed by the influx of funds, outflows and repositioning occurred when markets viewed some of the expansionary policies in the US as more likely to be unwound.

While macroprudential measures – and in extreme cases, capital controls – are some of the policy options available for addressing the currently intrinsic vulnerabilities of some capital-flow recipient periphery countries (IMF 2012), we point out that these vulnerabilities can also be addressed in part by financial stability reforms in centre countries.

Consider, for example, the consequences of the regulatory reforms pertaining to international banks that are currently being proposed or implemented. Improvements in the underlying financial strength and loss-absorbing capacity of global banks could have the beneficial side-effect of reducing some of the negative spillovers associated with unanticipated volatility in international banking flows – especially those to emerging and developing economies. Empirical research suggests that better-capitalized financial institutions, and institutions with more stable funding sources and stronger liquidity management, adjust their balance sheets to a lesser degree when funding conditions tighten (Gambacorta and Mistrulli 2004, Kaplan and Minoiu 2013). The result extends to cross-border bank lending (Cetorelli and Goldberg 2011, Bruno and Shin 2013).

While financial stability reforms may reduce the externalities of centre-country funding conditions, they retain the features of international banking that promote efficient allocation of capital, risk sharing and effective financial intermediation. By enhancing the stability of global institutions and reducing some of the amplitude of the volatility of international capital flows, they may address some of the objections to the destabilising features of the current system.

Cross-border capital flows that take place outside of the global banking system have recently increased relative to banking flows (Shin 2013). Regulation of global banks does very little to address such flows, and may even push more flows toward the unregulated sector. At the same time, however, regulators are considering non-bank and non-insurer financial institutions as potential global systemically-important financial institutions (Financial Stability Board 2014).


We have argued that the policy and institutional frameworks for financial stability are important new determinants of the relative roles of currencies in the international monetary system. Financial stability reform enhances the safety of reserve assets, and may contribute indirectly to the stability of international capital flows. Of course, the ‘old’ drivers of reserve currencies continue to be influential. China’s progress in liberalising its capital account, and structural reforms to generate medium-term growth in the Eurozone – as examples of determinants of the future international roles of the renminbi and the euro relative to the US dollar – will continue to influence their international currency status. Our point is that such reforms will not be enough. The progress achieved on financial stability reforms in major currency areas will also greatly influence the future roles of their currencies.

Authors: Linda Goldberg, Vice President of International Research at the Federal Reserve Bank of New York and Signe Krogstrup, Assistant Director and Deputy Head of Monetary Policy Analysis, Swiss National Bank; Member of the World Economic Forum’s Global Agenda Council on the International Monetary System

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TeamDepends's picture

The dollar is done, you killed it you wannabe Magi!!!!

wintermute's picture


It won't be the yuan or euro.

The Bitcoin network is now protecting its transactions with 200 million million million calculations per second [1000 calc equivalents per hash]


Anusocracy's picture

Given enough time, government will destroy everything it controls.

wee-weed up's picture

If the Fed has to ask...

"Could the dollar lose its status as the key international currency for international trade and international financial transactions,"

Then it's the best proof they don't have a fuckin' clue!

SoberOne's picture

Bye bye London fix and bye bye dollar. In due time.

philipat's picture

So, by virtue of having the equivlent in reserves of USD 5 Trillion (Possibly not including an undisclosed amount of Gold), her criteria seem to recommend CNY as a better reserve currency....??

y3maxx's picture

...Before the US Dollar loses its World Currency Reserve Fiat Status....Dollars to Donuts, be assured most of the Planet will be blown to bits first....No pun intended.

ebworthen's picture

As if the Bank of England never asked if the British Pound was at risk of losing its reserve status.


Harbanger's picture

Of course the US dollar will not be the reserve currency any longer, that's a good thing, it's only trouble.  And course of course a gov will destroy everything it controls, they always have, this has been known for like, forever bitchez.  But I don't care tonight because I'm enjoying my homemade brew,

"I've been a puppet, a pauper, a pirate, a poet, a pawn and a king.... 

I've been up and down and over and out and I know one thing....

Each time I find myself flat on my face....

I pick myself up and get back in the race. 

That's life, that's life, I tell you I can't deny it."

-Love you Frankie, you kept it real.




Salsipuedes's picture

This guy kept it real-er without kissing every politicians's ass from Kennedy to Kruschev to King George the First :  https://www.youtube.com/watch?v=tlm1kzWTrOI

Bad Attitude's picture

The next reserve currency will not be a digital currency like bitcoin because TPTB can't control it.

Forward (over the cliff)!

Toolshed's picture

"The next reserve currency will not be a digital currency like bitcoin because TPTB can't control it."

You are quite mistaken on that point.

withglee's picture

So what will it be ... and how will it differ from the USD or the Federal Reserve Note?

Greenskeeper_Carl's picture

"The horses got out! Quick, close the barn door!"

fauxhammer's picture

Ms. Goldberg appears to be a day late and a renminbi short

Escrava Isaura's picture

Consider this post by “Everybodys All American” .

I found it to be very insightful:

Everybodys All American: I differ. The Fed thinks they can control rates still. We shall see. Remember, the rest of the world is just as fucked economically. So maybe they have a chance and maybe they don't and use the backup plan below.

The loss of reserve currency status is not something any of these Fed governors want on their watch and that's what they are ultimately dealing with in addition to managing a ever rising 4.5 trillion balance sheet. A stock market crash is manageable but a dollar crash is not. That would be game over. So simply put they will hold their current balance sheet as long as possible without expanding it. The question to ask is what would possibly allow them to unload some or all of it? The answer is a stock market crash and a flight to the safety of US Treasuries. Rinse and repeat.

Tinky's picture

The author forgot to use a crucial set of quotes around the fifth word in this line:

...a flight to the safety of US Treasuries

Escrava Isaura's picture


The author, "Everybodys All American" did address it, indirectly:

"The Fed thinks they can control... We shall see. Remember, the rest of the world is just as fucked economically."


Just shoot the USD 12x at close range and she'll be history. 

IMACOINNUT's picture

After reading this twice and retaining the same conclusion each time, it occurs to me as a non-financial observer that we are fuked. This explanation by a so called wizard of econonics of the fed, is very disturbing as I learn that they haven't got a clue what to do to prevent the loss of reserve currency. 

Therefore if problems develop they will regulate, adjust, modify, reregulate and change policy to fix it. What a crock of shit.

One has to ask 'do these folks read the crap they print ' ? and if so do they not realize that many others do as well! So again, we are so fuked. They must be sure this is the end game of the fed and mainstreet America will be a banana republic.

bitterwolf's picture

yeah ,new paradigm shift to global electronic currency with g-20 something as stakeholders.same players-now integrated in a global cartel

RafterManFMJ's picture

NY Fed asks, "The plane has crashed into the goddamn mountain; are we fucked?"

Greenskeeper_Carl's picture

Ya. The fact that these people are even talking about it probably means it has already happened, there just isn't widespread recognition yet.

Cognitive Dissonance's picture

Fed says "If you are in front of the plane and I am in the back you're fucked before me." The insanity runs deep in the financial priest class.

Trade Guru's picture

The writing is on the wall.....but a move away from reserve status takes a very long time to unfold.

Everything currently happening in the East suggests this move is well under way already....ie...The BRICS bank and the vast number of trade agreements China already has with other countries ( 23 now  - and counting )


The rest of the planet won't put up with The U.S "abuse of worlds reserve" much longer.

More from Kong: http://forexkong.com/2014/04/01/china-reserves-gold-and-a-new-economy/

Winston Churchill's picture

Takes forty to fifty years in history.

The clock was started in 1971.

erg's picture

Could it lose it's reserve status?

Does Al Gore shit in the forest?

dirtyfiles's picture

first $US funeral guests?

Chupacabra-322's picture

The short answer:


emersonreturn's picture

wreally?  wreally & wreally--you think?!

nicoacademia's picture

they only asking this now? 



NOTaREALmerican's picture

How does that (old, very old and outdated) saying about bank defending themselves go:  If you have to say you're not bankrupt, you're bankrupt.

fuu's picture

The next reserve currency should be green shoots. They can print those all day on CNBC crawlers.

alexcojones's picture

That was the driest doom porn I've read in awhile.

RafterManFMJ's picture

I bought some Doom Jelli at WalMart - It's for those times when ZH doesn't have the time or is too drunk to properly warm you up.

bitterwolf's picture

cheap chinese shit dried up on me

Rican's picture

It was "for the ladies".

Greenskeeper_Carl's picture

It was pretty dry. And way longer than it needed to be.
"The fed printed too much money, and the us gov has run up far too much debt, more than it can ever repay, or even afford the interest on the debt in an environment of interest rates that are even close to normal. Therefore, the rest of the world no longer wants increasingly useless dollars or USTs, and are looking for an alternative"

Article complete. And I could have told them this years ago.

AdvancingTime's picture

We  are all interconnected for better or worse. A bad apple can spoil the whole basket. Welcome to the world our leaders have designed or allowed to form. Whether by design or merely as a byproduct of globalization we have weaved a web of financial transactions that circle the globe.

Over the last several years as money was printed by the central Banks it was not contained in the countries where in was printed. This money flowed across borders influencing and distorting markets and prices across the world. Some people have been calling for a "world currency" for years. the saying "one should never let a good crisis go to waste" means that a meltdown with high levels of fear would present a perfect opportunity and catalyst to advance this agenda down the field. Remember many people with agendas have a lot to gain when a major shift in the currency markets takes place. More on this subject in the article below.


mygameon's picture

Does a Yellen shit in the woods? Or is he simply into Asian scat and renminbi?

Caviar Emptor's picture

All we have to do is reinstate more pro-US puppet fascist military dictators in as many countries as possible like in the good old days.
Then watch king dollar return to the throne

techstrategy's picture

China will fractionally back RMB with gold and it is game over.

NOTaREALmerican's picture

Yeah, but as the guy above said:  WHY would the Chinese Elysium Class want the game to be over?

techstrategy's picture

Because we've become a 3rd world nation in terms of distribution of wealth and income, gutting our middle class, which has crushed our ability to grow consumption.  The dominant strategy for stability in China is to increase PPP adjusted income and reduce food costs (which can be 30-40% of income in China) for its people.  This also will create a wealth and income effect to increase domestic consumption in China.


All these slams are helping the Chinese accumulate enough gold to fractionally back the RMB... At a discount.

lasvegaspersona's picture


That is simply not going to happen. The Swiss figured that out and they  just had a good currency. Having a currency redeemable in gold would likely kill their export trade on day one.

himaroid's picture

Does Jim Willie have a Golden Jackass?

starman's picture

IMF can't wait to take over to implement "IMF draw"! 

No paper no coins only bank transactions! 

Welcome to the future!  

sixsigma cygnusatratus's picture

First they ignore you, then they ridicule you, then they fight you, then they say "I'm shocked this could have happened."  Then you win.