The great advantage of being a reserve currency is that the coin of the realm (mere worthless paper IOUs and promises) can be used to buy real tangible goods. Of course this requires a certain amount of wealth, power and acting with financial prudence and responsibility. Until the middle ages there was no such single country and gold and silver were the repositories of value. Britain and its currency, the sterling assumed the mantle up to WW2, when America replaced it. The backbreaking costs of the two world wars and the reality that all the blood had already been squeezed out of the colonies, which now needed transfusions of capital, combined with the determination of new hegemon's President Roosevelt to dismantle the British Empire, led to the demise of the pound as a reserve currency. The foolish guns and butter policy of Johnson limited American primacy to a few decades, before De Gaulle fired the first shot across the bow and sank the gold parity and convertibility of the dollar under the Nixon presidency. The Bretton Woods accord was abandoned and floating currencies came into being.
The subsequent roller-coaster gyrations of the dollar and the enlarging EU led to the Euro and the rising economic might of Japan, constrained by its military weakness led the Yen to become alternative minor reserve currencies. The irresponsible profligate spending of America under Reagan to Bush2 the last straw, has broken the American camel's back. It is following Keynesian deficit policy not for its original intent of stabilizing a recessionary sinking national economy and increasing employment, but for a reckless spending binge. It claims to be an engine of growth for the world. It does provide employment for manufacturers the world over, but it pays them in a depreciating worthless paper currency.
In 2004 China increased it reserves by over 200 billion dollars despite spending 50 billion dollars to refinance its bankrupt banking system. At some point the foolishness of accepting worthless paper for real tangible goods will stop as warned by the Federal Reserve Chairman Greenspan. America is getting a free ride by running the printing presses overtime to print more dollars. It knows that if one owes a creditor a big sum, the creditor owns you and can dictate to you, but if one owes the creditor the bulk of the creditor's worth then the debtor owns the creditor and can dictate to him. America is not unaware of the currency history of the Weimar Republic but knows that it is an unchallengeable and not defeated superpower. It thus writes checks which need not be honored. Shortsighted and unthinking parties or those without recourse accept the dollars and recycle them by buying US Treasuries at low interest rates, thus taking double losses of exchange rates and negative inflation adjusted interest rates, while stimulating the US economy and perpetuating the reckless spending binge of the irresponsible American consumer.
Japan has lost 14% of its dollar holdings value. Korea and India have lost 10%. China and Hong Kong have pegged their currencies to the dollar but China needs the exports to provide jobs for its masses and the latter is its puppet. The relationship like tat of an abused spouse reluctant to rock the status quo and plunge into the unknown realm of divorce is changing. China is diversifying its reserves into Euros and its companies are buying up huge international companies to acquire expertise, technology and to spend depreciating dollars. Thus it is signing energy deals with Sudan, Iran, Russia, Kazakhstan and Canada; buying France's Thomson TV manufacturing to become the world's premier TV manufacture and, America's IBM personal computer line and may even buy Unocal a major energy producer. It is signing deals with Australia, Brazil and Argentina for long-term supplies of ore, minerals and agricultural commodities and wooing small African nations with dollops of foreign aid.
India has done some of this in energy deals with Sudan, Iran and Russia. Reliance, Tatas, Bharat Forge, Wipro and Infosys have bought some foreign companies and some of the high interest foreign loans have been paid up, but the huge bulk of the dollar reserves lie unused or earning a negative rate of interest by being parked in US Treasuries. This is the time to buy Western companies and technology and to use the reserves to buy American equipment and thus return the depreciating dollars to America for tangible goods and earn its goodwill by reducing its trade and current account deficit. The use of these dollars to buy infrastructure building machines will also increase Indian employment in projects like the golden quadrilateral. India is much less dependent than China on exports to America for increasing its employment and thus not constrained to keep fixed currency rates, so it should only keep a comfortable cushion of reserves and pass on this parcel to someone else for real necessities and goods instead of being left holding the worthless bag of paper when the music stops, as one day soon it surely will.
The government and industrialists need to set up manufacturing units for cell-phones, computer chips and keep climbing up the curve in manufacturing as Japan, Taiwan and Korea have done. Singapore, Malaysia, Sri Lanka, Thailand, Vietnam, Cambodia, Laos are countries where India and Indian companies should be setting up subsidiaries or making acquisitions to expand their base. Eastern Europe should be on the horizon but only Mittal Steel and one other India based enterprise have acquired factories there when cheap asset fire-sales were going on. Let us not miss the soon oncoming bargain basement sale of American technology. There is an unfortunate lack of vision and foresight in Indian governments and industrialists. Interestingly the blinders fall off spontaneously in those Indians who have settled abroad for a few years as the expansive and long-term strategies of the Gulf and UK based Indian industrialists prove. There is an apocryphal story of a foolish Indian miser who never used his assets for personal wants or pleasure, nor for the need and joy of others, but buried his paper assets in his backyard in a wooden box. When he dug them up later for the vicarious pleasure of tallying them, he found that the termites had digested his wealth! A fool and his money are soon parted and this is why pyrite, an iron ore whose mineral veins look like gold is also called fool's gold.