Countries with Reserve Currency are Likely to Face Hollowing out of Mid-Tier Manufacturing

Abstract

Reserve currency is the world’s ballast against economic gyrations and meltdown. It must be construed as a public good in the sense that the country issuing the reserve currency needs to withstand daily demand fluctuations on the currency that can create economic instability at home, and is vulnerable to importing inflation from trading partners using its reserve currency as domination currency. In some cases, the cost of having a reserve currency may be higher than its benefits. One more cost is the potential of hollowing out of the country’s mid-tier manufacturing. Specifically, countries with reserve currency such as the United States and United Kingdom face strong demand for their currency as investment vehicles or safe haven deposits. But, such demands on the currency will drive up the price of the currency making both reserve currencies stronger. At economic equilibrium, a stronger currency will hamper exports, and this will transmit to higher manufacturing cost of goods, making mid-tier products less competitive internationally. The ultimate result is the hollowing out of the country’s mid-tier manufacturing. Overall, while it is generally perceived as having a strong advantage to have a reserve currency, this may not be the case as strong demand for the currency will drive up the price of the reserve currency, making exports more difficult, and a gradual loss of competitiveness and hollowing out of mid-tier manufacturing.

Keywords: reserve currency, mid-tier manufacturing, public good, loss of competitiveness, hollowing out