Traditionally, G3 currencies have been drawn from the world's largest economies. But with China's economy overtaking Japan's and Germans wanting the Deutsche mark back in the wake of the Eurozone debt crisis, the dollar, euro and yen have become flawed as an exchange rate bloc.
Instead the Canadian dollar, Australian dollar and Swiss franc are becoming increasingly traded in the foreign exchange markets. This is fitting as they represent an alternate group of 'shadow currencies' for investors wishing to take directional bets on - or hedge investments in - the US, China and Germany.
The S3 currencies lack the liquidity of the G3 currencies, but they have several advantages. First, close trade links make the Canadian dollar, Australian dollar and Swiss franc strong substitutes for the US dollar, Chinese yuan and old Deutsche mark. The US alone accounts for 75% of Canada's exports, China 25% of Australia's and Germany 20% of Switzerland's. Thus when economic conditions change in the world's leading economies, the Canadian dollar, Australian dollar and Swiss franc react, given the US, China and Germany are the primary trading partners of Canada, Australia and Switzerland respectively.
Second, none of the S3 bloc is hampered by fiscal risks or weak growth. The IMF estimates that Canada's gross government debt will be 75% of GDP in 2015 compared with 109% in the US. Switzerland's will be 48% of GDP compared with 75% in Germany and Australia's will be just 22% of GDP. China's gross government debt ratios are low but local government debt has increased sharply over the last few years.
Last, all the S3 currencies are freely floating, in contrast to the yuan, and each can be traded, in contrast to the mark.
As a result the Canadian dollar, Australian dollar and Swiss franc have risen in prominence as investors seek alternatives to the G3 currencies. The shadow currencies' combined share of daily foreign exchange turnover has almost doubled over the last decade according to the BIS, and their estimated share of total foreign exchange reserves now exceeds central bank holdings of the pound or the yen, based on data from the IMF.