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An Exploration of Safe Assets, Safe Haven Currencies, and Exchange Rate Volatility

By Megan Doyle

Safe assets and safe haven currencies like the U.S. dollar have traditionally been used as a means of protecting investments against losses, including from foreign exchange rate volatility, but ideas about safe assets have changed over time—and continue to do so. For one, a number of surprises were revealed in the mid-2000s when several dollar-denominated assets thought to be safe failed anyway, contributing to the Great Recession. Now, a decade later, the idea of replacing the dollar as the world’s reserve currency seems to be gaining traction as interest grows in global digital currencies.

In this six-part series, financial journalist Frances Coppola examines the history, evolution, and potential future of safe assets and safe haven currencies, paying specific attention to the historical ramifications of FX volatility and the dollar’s persistent role as the world’s reserve currency.


Part 1: How Monetary Sovereignty Affects Exchange Rate Volatility


Satisfying the three conditions of economists’ “trilemma” theoretically leads to monetary sovereignty. Still, some countries that should be economically stable, in theory, are not in reality. The first article in the series explains how the concepts of “exchange rate pass-through” and “developed market privilege” shed light on why the trilemma seems to apply better to some countries than others, what it all means for safe haven assets, and how monetary sovereignty affects exchange rate volatility.


Part 2: 1990s Exchange Rate Volatility Helps Make Developing Countries Safer Partners


In the 1990s, high foreign exchange rate volatility caused several FX crises across the globe. This article explores the causes of those crises, starting with Mexico’s “tequila” crisis of 1994-5 and ending with Argentina’s sovereign default in 2001. The crises taught many developing countries to build up large FX reserve buffers that protect against FX risk and make them more attractive trading partners for U.S. export businesses.


Part 3: When Safe Assets Fail, What Happens to Safe Haven Currency Exchange Rates?


So-called “safe assets” and “safe haven currencies” are sought after precisely because they’re considered safe, but the global financial crisis leading up to the Great Recession of 2008-09 revealed that they’re not always risk-free. This article examines the failure of dollar-denominated safe haven currency assets during the first half of the 2000s, how it affected the dollar’s exchange rate, and what it meant for currency exchange rates around the world.


Part 4: Pursuit of ‘Safe Haven’ Currencies & ‘Safe Assets’ Set the Stage for Great Recession


After the FX volatility crises of the 1990s, many countries worked to build up reserves of safe haven currencies to mitigate FX risk. The U.S. quickly became the primary supplier of safe assets for the world, but this period of “global savings glut” caused a growing U.S. account deficit and a depressed dollar exchange rate. This article dives into why the pursuit of safe assets helped pave the way for the Great Recession.


Part 5: Could the Dollar be Replaced as the World Reserve Currency?


Economists have long pondered the possibility of another currency replacing the dollar’s role as the world’s reserve currency. In addition to explaining what a world reserve currency is and what it means for foreign exchange rates, this article explores several possible alternatives to the dollar’s role as world currency, including a “multi-polar” system and a new global monetary system with a universal trade settlement currency based on the International Monetary Fund’s special drawing rights (SDR) currency basket.


Part 6: Is a Global Digital Reserve Currency on the Horizon?


Global digital currencies like bitcoin and ethereum are already here, making a global digital reserve currency possible. This article explores whether a new digital world reserve currency would be dependent on central banks, issued by central banks, or entirely independent of central banks. It peeks into the future by investigating the possibility of a global digital reserve currency and how it could affect the global demand for safe assets.

Megan Doyle - The Author

The Author

Megan Doyle

Megan Doyle is a business technology writer and researcher based in Wantagh, NY, whose work focuses primarily on financial services technology.

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