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Trust is the new reserve currency in times of economic turbulence

Posted in Finance Articles, Total Reads: 2971 , Published on December 03, 2011

The burgeoning rate at which fire of sovereign debt crisis is destroying countries gives a little time to think of solution. Greece, Iceland, Portugal, Spain and Italy are the notable casualties. In case one believes that debt crisis is prevalent only within the territories of Europe and America, then, it’s completely a misjudgment. The debt crisis marked its presence in Asian and African continents decades ago.

Trust As Global Currency

As countries join the queue to jump into well of debt crisis, the common perception that developed countries being capable enough to pay off the debt is fading slowly. The result of this notion can be hazardous. Let us look why.

Sovereign credit default swaps

One of many factors which determine the robustness of a nation to pay off the debt is credit rating. A credit rating depicts the ability of a nation to pay off the debt. Higher the credit rating is, better are the chances of a nation to pay back the debt. Developed countries, owing to their robust financial reputation were regarded highly by the credit rating agency. The silhouette of reputation was recently shattered by an agency named Standard & Poors, when it downgraded1 US credit rating from AAA to AA+. Panic spread across the world with countries drawing out their burnt fingers (i.e. investments) from the US capital market.

Countries are turning shy to invest into international opportunities, citing uncertainties and apprehensions. With devaluation of currencies, securities and rumors about gold bubble cropping up, the reserve currencies are at risk from being jeopardized. If one introspects deep further into the scenario at present, he/she can make out that the world should have been bankrupted by now.

So what keeps the world economy ticking despite the string of crisis? It is ‘trust’. Yes, it is the same five lettered world which is the invisible hand behind all successful associations and businesses. Had there been lack of trust between nations, EU wouldn’t had bailed out Greece, US wouldn’t had been granted further debts and developing countries would had been wiped out by now.  While one may argue that every action is based on vested interest, the truth of present is, virtually most of the nations have their debt exceeded the GDP(which indicates their revenue). And in simple accounting terms when debt exceeds revenue, an organization runs at potential risk of bankruptcy.

Can we envisage trust as the new reserve currency at this time of economic turbulence? Yes.

A reserve currency is a foreign currency held by central banks and other major financial institutions as a means to pay off international debt obligations, or to influence their domestic exchange rate. A large percentage of commodities, such as gold and oil, are usually priced in the reserve currency, causing other countries to hold this currency to pay for these goods. Holding currency reserves, therefore, minimizes exchange rate risk, as the purchasing nation will not have to exchange their currency for the current reserve currency in order to make the purchase2.

In fact trust is the most popular reserve currency which has been used in trades and transactions between nations. Trust provides a reason why developed countries pump millions into developing and under developed countries, despite the disability of borrowers to pay the sum back. It may not be surprising to infer that trust was the majorly traded currency reserve in the earth.

While the countries continue to battle the financial tides in the ocean of world, the watershed between floating and sinking is diminishing every day. The question that pops up in everyone’s mind is how long would the thin line continue to exist? The day when the watershed would be perished, we would find ourselves in a condition that Norstradamus3 had predicted centuries ago. As of now, every generation remains optimistic of the countries to sustain the financial crisis, with a hope that they do not see an abrupt end of the world.


1-     http://www.bloomberg.com/news/2011-08-06/u-s-credit-rating-cut-by-s-p-for-first-time-on-deficit-reduction-accord.html

2-     http://www.investopedia.com/terms/r/reservecurrency.asp#axzz1bpEZsLm5

This article has been authored by Sidharth Panigrahi from TAPMI, Manipal.

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