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Hard currency (also known as a safe-haven currency or strong currency), in economics, refers to a globally traded currency that is expected to serve as a reliable and stable store of value. Factors contributing to a currency's hard status might include the long-term stability of its purchasing power, the associated country's political and fiscal condition and outlook, and the policy posture of the issuing central bank.
Conversely, a soft currency indicates a currency which is expected to fluctuate erratically or depreciate against other currencies. Such softness is typically the result of political or fiscal instability within the associated country.
Many currencies are neither hard nor soft.
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Varying theories of monetary policy, and the ever-present risk of unexpected geopolitical and policy events, preclude any claim of a currency's hardness from being called definitive. Precious metals have been the most resilient currencies, with physical gold historically outlasting all forms of paper fiat money and gold certificates.
Quantitative easing, credit downgrades, and other events of the late-2000s financial crisis have generally eroded the security of most fiat money, making it difficult to define any as a hard currency.
The paper currencies of some developed countries have earned recognition as hard currencies at various times, including the United States dollar, Euro, Swiss franc, British pound sterling, Japanese yen, and to a lesser extent, the Canadian dollar and Australian dollar. Times change, and a currency that is considered weak at one time may become stronger, or vice versa. However, countries that consistently run large trade surpluses, tend to have hard currencies, China's currency can be considered hard, though not convertible.
One barometer of hard currencies is how they are favored within the foreign-exchange reserves of countries. It should be noted that the presence of the US dollar in such reserves is due largely to the Bretton Woods System. In addition to the chart below, see also Gold reserves.
| '95 | '96 | '97 | '98 | '99 | '00 | '01 | '02 | '03 | '04 | '05 | '06 | '07 | '08 | '09 | '10 | Latest Data '11 Quarter III |
|
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| US dollar | 59.0% | 62.1% | 65.2% | 69.3% | 71.0% | 70.5% | 70.7% | 66.5% | 65.8% | 66.0% | 66.4% | 65.7% | 64.1% | 64.1% | 62.1% | 61.7% | 61.7% |
| Euro | 17.9% | 18.8% | 19.8% | 24.2% | 25.3% | 24.9% | 24.3% | 25.2% | 26.3% | 26.4% | 27.6% | 26.0% | 25.7% | ||||
| German mark | 15.8% | 14.7% | 14.5% | 13.8% | |||||||||||||
| French franc | 2.4% | 1.8% | 1.4% | 1.6% | |||||||||||||
| Pound sterling | 2.1% | 2.7% | 2.6% | 2.7% | 2.9% | 2.8% | 2.7% | 2.9% | 2.6% | 3.2% | 3.6% | 4.2% | 4.7% | 4.0% | 4.3% | 4.0% | 3.9% |
| Japanese yen | 6.8% | 6.7% | 5.8% | 6.2% | 6.4% | 6.3% | 5.2% | 4.5% | 4.1% | 3.8% | 3.7% | 3.2% | 2.9% | 3.1% | 2.9% | 3.7% | 3.8% |
| Swiss franc | 0.3% | 0.2% | 0.4% | 0.3% | 0.2% | 0.3% | 0.3% | 0.4% | 0.2% | 0.2% | 0.1% | 0.2% | 0.2% | 0.1% | 0.1% | 0.1% | 0.1% |
| Other | 13.6% | 11.7% | 10.2% | 6.1% | 1.6% | 1.4% | 1.2% | 1.4% | 1.9% | 1.9% | 1.9% | 1.5% | 1.8% | 2.2% | 3.1% | 4.5% | 4.8% |
| Sources: 1995-1999, 2006-2010 IMF: Currency Composition of Official Foreign Exchange Reserves Sources: 1999-2005 ECB: The Accumulation of Foreign Reserves |
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Note from 2006–2011, far from the fears of US dollar demise or Euro rise, the trend has been moving away from the traditional hard currencies towards the "Other" category.
The US dollar (USD) has been considered a strong currency for much of its history. Despite the Nixon shock of 1971, and the United States' growing fiscal and trade deficits, most of the world's monetary systems have been tied to the US dollar due to the Bretton Woods System and dollarization. Countries have thus been compelled purchase dollars for their foreign exchange reserves, denominate their commodities in dollars for foreign trade, or even use dollars domestically, thus buoying the currency's value. However the late-2000s financial crisis saw the institution of quantitative easing by the Federal Reserve, downgrades of US debt by credit rating agencies (during the debt-ceiling crisis), countries diversifying their foreign exchange reserves away from the dollar, the emergence of commodity markets trading in non-US currency (such as the Iranian oil bourse), resumed appreciation of the yuan by the People's Bank of China, and the IMF proposal of the SDR as an alternative to the dollar in some applications. These events and others have eroded confidence in the US dollar.
The euro (EUR) has also been considered a hard currency for much of its short history, however the European sovereign debt crisis has eroded that confidence, with many predicting the currency's demise.
The Swiss franc (CHF) has long been considered a hard currency, and in fact was the last paper currency in the world to terminate its convertibility to gold. In the summer of 2011, the European sovereign debt crisis lead to rapid flows out of the euro and into the franc by those seeking hard currency, causing the latter to appreciate rapidly. On September 6, 2011, the Swiss National Bank announced that it would buy an "unlimited" number of euros to fix an exchange rate at 1.00 EUR = 1.20 CHF, to protect its trade. The franc fell precipitously against the euro to match this rate, and the price of gold in CHF rose 5% in a matter of minutes. This action has, at least temporarily, eliminated the franc's hard currency advantage over the euro.
In the midst of the ongoing financial crisis, countries with strong currencies are at risk of capital inflows causing appreciation. The potential impact of such appreciation on a nation's economy is historically unprecedented due to globalization and free trade. Thus the world's central banks are locked into a spiral of "competitive devaluation" in which the value of all fiat money systems is being eroded.[1] This process is reflected in the escalating price of gold — investors flock to gold and other precious metals as a store of value and hedge against inflation, which causes the price to increase rapidly, sometimes for several consecutive years and recently, at many times more than the rate of inflation. [2]
Investors as well as ordinary people generally prefer hard currencies to soft currencies at times of increased inflation (or more precisely increased inflation differentials between countries), at times of heightened political or military risk, or when they feel that one or more government-imposed exchange rates are unrealistic. There may be regulatory reasons for preferring to invest outside one's home currency, e.g. the local currency may be subject to capital controls which makes it difficult to spend it outside the host nation.
For example, during the Cold War, the ruble in the Soviet Union was not a hard currency because it could not be easily spent outside the Soviet Union and because the exchange rates were fixed at artificially high levels for persons with hard currency, such as Western tourists. (The Soviet government also imposed severe limits on how many rubles could be exchanged by Soviet citizens for hard currencies.) After the fall of the Soviet Union in December 1991, the ruble depreciated rapidly, while the purchasing power of the U.S. dollar was more stable, making it a harder currency than the ruble. A tourist could get 200 rubles per U.S. dollar in June 1992, and 500 rubles per USD in November 1992.
In some economies, especially planned economies or those using a soft currency, there are special stores that accept only hard currency. Examples have included Tuzex stores in the former Czechoslovakia, Intershops in East Germany or Friendship stores in the People's Republic of China in the early 1990s. These stores offer a wider variety of goods — many of which are scarce or imported — than standard stores.
Because hard currencies may be subject to legal restrictions, the desire for transactions in hard currency may lead to a black market. In some cases, a central bank may attempt to increase confidence in the local currency by pegging it against a hard currency, as is this case with the Hong Kong dollar or the Bosnia and Herzegovina convertible mark. This may lead to problems if economic conditions force the government to break the currency peg (and either appreciate or depreciate sharply) as occurred in the Argentine economic crisis (1999–2002).
In some cases, an economy may choose to abandon local currency altogether and adopt a hard currency as legal tender. Examples include the adoption of the US dollar in Ecuador and El Salvador, and the adoption of the German mark and later the euro in Kosovo and Montenegro.
Fractional reserve banking causes there to be more chits redeemable for gold in circulation than actual gold reserved, thereby devaluing the physical metal. Thus in times of financial distress, physical gold is preferred over chits redeemable at possibly troubled banks for gold. As economies improve, banks lending metal based currency then create more chits for gold, again devaluing the gold. Only the Bank of Amsterdam has historically operated with a reserve ratio of 1.
Even under a gold standard with a sensible reserve ratio, currency can be (further) devalued by chits redeemable for currency produced elsewhere in a race to the bottom, as foreign banks may choose to lend the currency (gold based or not) while operating with a lower level of reserves. Specifying a suitably low reserve ratio with bank regulation allows the banks under the jurisdiction of a regulator to garner a large portion of market share for lent money by offering an attractive mix of low interest rates and relative safety. 1/10 is a popular reserve ratio around the world that has largely supported the financial relevance of banks under national regulation.
Thus, because of fractional reserve banking, paper gold is not necessarily a hard currency during boom times.