The debate over the U.S. dollar's reign as the world's reserve currency continues to make headlines. Recent developments, especially the U.S. sanctions agains Russia after its invasion of Ukraine, have catalyzed the de-dollarization trend.
This movement seeks to decrease the U.S. dollar’s role in international trade. However, despite these shifts, it’s hard to contest the formidable presense of the U.S. dollar. Here’s why the concerns surrounding de-dollarization might be overstated.
WHY THE U.S. DOLLAR REIGNS SUPREME
Store of Value: A crucial function of any currency is its role as a store of value. In 2022, the dollar made up 58% of global foreign reserves, surpassing the euro (21%) and the yuan (3%). The U.S. sanctions against Russia post-Ukraine invasion haven’t caused a significant shift in these reserves (Source: IMF, COFER).
Medium of Exchange: Recent data shows the dollar is the primary medium for trade, with 96% of trade in the Americas, 74% in the Asia-Pacific, and 79% elsewhere using it. Europe remains an exception, favoring the euro at 66% (Source: IMF Direction of Trade). The U.S. dollar also prevails in international banking with 60% of foreign currency claims being dollar-denominated (Source: BIS locational banking statistics).
Unit of Measure: The U.S. dollar is the principal currency for foreign currency debt, where the percentage of foreign currency debt denominated in U.S. dollars has remained around 70% since 2010, in comparison to the euro’s share at 21% (Source: Refinitv). And notably, the lion’s share of global oil trade is denominated in U.S. dollars, also strengthening its demand.
Reliability & Stability: Stability is a cornerstone of any reserve currency. The dollar’s robustness stems from the U.S.’s commitment to property rights, rule of law, and a strong economic foundation. Events like the 2008-2009 financial crisis and the COVID-19 pandemic underscored the Federal Reserve’s proactive approach by offering swap lines to foreign countries, solidifying its reputation as a stabilizing force in global finance (Source: Federal Reserve Bank of New York).
POSSIBLE ALTERNATIVES: A CLOSER LOOK
The U.S. dollar as a share of global central bank reserves has dropped from 72% in 2002 to 58% in 2022 (Source: Goldman Sachs Asset Management). Nonetheless, this trend does not come at the cost of a sudden rise in dominance by another global currency backed by ally or enemy state. To illustrate this, it makes sense to ask, “What could replace the dollar?”
The Euro: The euro’s 20+ year track record offers some potential. However, it faces internal challenges due to EU member state disagreements. Furthermore, past financial crises have diminished its global prominence. Nevertheless, increased European integration could boost its global role.
The Yuan: China poses a modest challenges to the U.S. dollar due to its expanding global ties and as the world’s largest exporter. Despite its size, China’s bond market is approximately $20 trillion where the U.S. bond market is approximately $51 trillion (Source: GSAM). More importantly, China’s population is in decline, Chinese markets are less open and transparent, their housing market faces structural and significant challenges, and youth unemployment exceeds 21% (source: CNBC). Finally, trust and confidence in the Chinese government and insitutions is relatively low, making the Chinese yuan unattractive for international investors.
The BRIC: Led by the U.S., the world’s curshing sanctions against Russia, albeit necessary had the knock-on effect of sending a message to adversaries that they must immediately become less reliant on the dollar. Brazil and Malaysia, Russia, India, and China (BRIC), among others, seek to set up trade channels using currencies other than the dollar. While this would reduce the dollar position among those countries, it is a stretch to argue that this will facilitate adoption of those currencies or a new “BRIC” currency.
Digital Assets (aka “Crypto): A shifting payments landscape due to the rapid growth of digital currencies could reduce reliance on the U.S. dollar. A Bank of International Settlements survey found that 93% of the world’s central banks are working on a Central Bank Digital Currency (CBDC). But the digital asset ecosystem is still young and faces an uphill regulatory environment. That said, it is also possible that technological progress may solidify the dominant role of the dollar, where 99% of the stablecoin market capitalization is linked to the U.S. dollar (source: CoinMarketCap.com)
Despite shifts in the global economic landscape, the U.S. dollar’s stronghold seems secure. Research by Bertaut, von Beschwitz, and Curcuru (2023) reveals that the dollar’s international usage has remained stable over two decades, overshadowing its nearest competitor, the euro. While international usage of the Chinese yuan has increased over the past 20 years, it has only reached an index level of about 3 versus the dollar at 70.
A modest weakening dollar should not be feared – rather, there are benefits. For the dollar to maintain its reserve status, the U.S. must maintain persistent trade deficits, putting strain on the economy. A softening of the dollar increases the competitiveness of U.S. exports and fosters tourism.
While persistent fears of the dollar losing its hegemony circulate, they are largely overblown. It remains unlikely that any currency will dethrone the dollar in the foreseeable future. Given its historical track record, robust economic infrastructure, and the intricate web of global financial systems intertwined with it, the U.S. dollar is poised to remain the world’s preeminent reserve currency.