fifty50. / is the U.S. dollar dying?

In recent weeks there has been a plethora of headlines claiming that the U.S. dollar is dying. That couldn't be further from the truth.

In recent weeks there has been a plethora of headlines claiming that the U.S. dollar is dying, on its way to be replaced as the world’s most trusted reserve currency. There are many pundits arguing that China’s currency, called interchangeably either the renminbi or yuan, will replace the U.S. dollar. 

This couldn’t be further from the truth.

Firstly, if the U.S. dollar lost its status as the global reserve currency, it would be an enormous blow to the U.S. status as a superpower. A global reserve currency is the currency that the international community prefers to trade-in and have-on-hand for its high stability and liquidity (meaning assets in that currency can easily be turned into cash). The central banks of foreign governments maintain high amounts of U.S. dollars in their foreign exchange reserves so that it  is available for paying off debt and conducting trade. As of 2022, just under 60% of all foreign exchange reserves are in the dollar. 

Having the U.S. dollar as the reserve currency affords us many privileges. Firstly, we can easily rack up national debt since dollars are in high demand, meaning the cost of borrowing is low. And more importantly, we can extend our influence to every corner of the globe: any trade between two parties that happens in U.S. dollars (and 88% of international transactions are) must abide by U.S. laws. Of course, we know the U.S. weaponized the dollar against Russia - freezing nearly half of their reserves and removing them from the U.S. dollar denominated SWIFT banking system (which handles communications to facilitate international payments) - but there are countless other examples of the U.S. extending its reach globally. Recently, the U.S. fined a French bank around $9 billion for violating the U.S.’ sanctions to Cuba, Sudan, and Iran. Even though it was a payment that had nothing to do with American citizens, since it was in U.S. dollars, our government could reign in France to follow our laws. The French were pissed. 

Because of this, preserving the dollar as the global reserve currency is an utmost priority for American leadership in maintaining our worldwide sphere of influence.

addressing other countries’ attempts to de-dollarize.

Most relevant in this conversation is China. China has rallied against U.S. dollar dominance many times, and has recently agreed to billions in trade deals with Russia that will use the Chinese yuan. However, the mechanism China employs to promote the use of local currencies over the dollar is the Shanghai Cooperation Organization (SCO), through which it has given enormous unprecedented access to the yuan to Uzbekistan, Russia, Kazakhstan, Pakistan, Mongolia, Turkey, and others via bilateral currency swap agreements. These agreements essentially makes it cheaper for these countries to use and trade in Chinese yuan, making it a more powerful regional currency. But, let’s zoom out for a second: these de-dollarization policies have been in play since 2008, and in 2022 the Chinese yuan represented just 2.69% of the global currency reserves. Let me say that again: the Chinese yuan is only 2.69% of global currency reserves.

While I am sure some Chinese leaders would love to have their currency topple the dollar (and we will address structural limitations to that happening later), the country’s true purpose is to cushion itself from any instability in the U.S. dollar and subvert U.S. sanctions against Russia so that it can buy and sell at a discount to Putin’s rogue nation. Complete de-dollarization is still a far-fetched dream.

And maybe they won’t admit it, but China is addicted to the U.S. dollar - their foreign exchange reserves hold the second-highest amount of U.S. currency of any country (the first is Japan). This is not because of some malicious reason to one-day secretly sell-off all of the debt and put the U.S. into a frenzy as some highly-skeptical scholars will tell you. It is because China is dependent on export-led growth (they want everything to bear the label “Made in China”) and by having high amounts of U.S. dollars in their reserves, it allows them easy access to it when trading so as to keep the cost of exports lower. 

Others also want to challenge U.S. dollar supremacy. French President Emmanuel Macron has said Europe must reduce dependence on the dollar, while India and China have inked many trade deals that will use their own currencies. Specifically focusing on India, many have said its new trade policies with Russia, Malaysia, Sri Lanka, and others that will use the Indian Rupee in place of the U.S. dollar, is the first sign that support for the dollar is fraying. 

But again, that’s not really the case. If you zoom out, this is a result of the U.S. dollars’ appreciation against other currencies over the last year - in international trade, a country must purchase U.S. dollars in order to conduct trade in that currency, and this means that the cost of those U.S.-dollar denominated goods have gone up. India's true purpose is to reduce international trade costs by promoting its own exports to countries that are struggling with access to U.S. dollars (i.e. Russia, Sri Lanka, Bangladesh) who either cannot afford it or, in the case of Russia, are sanctioned from using it.

addressing the decline of the US dollar in global reserves.

Many experts will point to how the U.S. dollar has made up a smaller and smaller share of global foreign currency reserves, today at a two-decade low. In 2000, it made up 71% of global reserve, then in 2016 dropping to 65%; now it is at just 58%.

Firstly, let’s acknowledge this: since 2016, while the use of the dollar has dropped by 7 percentage-points, the use of Chinese yuan in reserves has only gone up by 1.61 percentage-points. So, anyone arguing that foreign central banks are dropping the U.S. dollar in exchange for the Chinese currency are wrong. Not to mention, the Russian central bank holds a third of its reserve in Chinese yuan and is one of the largest holders of Chinese currency globally. All this has accomplished is made Putin more victim to Xi Jinping’s influence. 

So what are banks using instead of the dollar? Essentially a mix of small-economy currencies that, together, offer high returns with manageable volatility. This is a consequence of the Federal Reserve (until recent) maintaining relatively low rates for the better part of the last two decades - this means that yield that foreign central banks get for holding the U.S. treasuries (which is the common holding they use to maintain U.S. dollars in their reserves) is lower than what a mix of various small-economy currencies provides. This is aided by the rise of new financial technology that makes it easier to hold and trade these less-available local currencies.

Below, you can see while the dollar’s presence in reserves declines, the use of “other” currencies upticks.

Secondly, it is largely ignored that the U.S. has purposely tried to decrease the amount of dollars in foreign reserves. 

A world highly dependent on the U.S. dollar is not a safe one: if there is a crisis in the U.S. financial sector, investors may start selling U.S. assets, causing the value of the dollar to decline. This can cause other countries holding U.S. dollars to experience losses (since an enormous portion of their reserves is suddenly worth a lot less), which can lead to a reduction in their own currency values, and cause investors to withdraw investments from those countries. This spurs a global financial meltdown, and with no one having access to a stable market, a recovery would be slow and painful.

So, for the last three decades, the U.S. has purposefully promoted currency diversification amongst allies and partners. In the late 90s, American leaders encouraged the unification of a single European currency (the Euro) to take the place of the U.S. dollar in inter-European trade; in campaigning for enormous reduction in dependence on the dollar, President Clinton’s Treasury Secretary said it would bring “balance and diversity” to global financial markets. The U.S. has even come to support the Chinese-launched Asian Infrastructure Investment Bank, specifically citing how it will promote the use of local currencies. Through the IMF, the U.S. has encouraged foreign central banks to use a basket of currencies rather than just a single reserve currency (called Special Drawing Rights).

addressing the U.S.’s weaponization of the dollar. 

Many argue that since the U.S. leveraged the dollar’s hegemony status in order to place sanctions on Russia, it encouraged other countries to drop the dollar in order to hedge against any risk of having to feel the U.S.’ wrath. After all, 86% of the world’s population do not live in a country that has condemned or sanctioned Russia.

However, the data doesn’t agree. The IMF reveals that in Quarter 4 of 2020, right before the invasion and sanctions, roughly 55% of the global foreign currency reserves were in dollars. At the end of 2022, it was 54%. Most of the sell-off in U.S. dollars (though not even a significant amount) is explained by central banks trying to strengthen their own currencies. In the end, it is clear that trust in the dollar remains strong.

there are concerns for the U.S. to address.

In the 19th and early 20th century, it was the United Kingdom’s pound sterling that served as the global reserve currency. That was until high inflation, low growth, and overbearing national debt made the pound less favorable to America’s dollar, seen as a bastion of a high-growth and high-promising nation. Sound familiar?

After both the World Wars, the UK had racked up enough debt to account for 240% GDP. Shortly after, the Bretton Woods conference of 1944 (which took place in my home-state, the great state of New Hampshire) formalized the U.S.’ takeover as the reserve currency.

While the U.S. hasn’t porked up its national debt as much as the U.K. did, currently only at 120% of GDP, it is on track to make the same mistakes. Short-termism has resulted in Democrats keep spending, and Republicans keep cutting taxes, without either side offering real solutions to reign in our growing debt. China (and its BRICS allies) continues to outpace the U.S. on growth, and it will eventually become the world’s largest marketplace. If not replace the dollar’s hegemony, it can dilute its presence enough to limit American influence - that remains a threat.

The U.S. also is still making a fool of itself on the global stage by not swiftly passing legislation to increase the debt ceiling, which it reached earlier this year. Global markets see the risk of a U.S. default very low (otherwise we would be seeing a major sell-off in U.S. treasuries), but it puts our political instability on display for the world to judge.

closing thoughts: the dollar is the dominant reserve currency not by mandate, but by choice.

Still, despite these risks, the dollar dominates not because of any law, but because it offers what no other country can. Yes, American political instability is an issue - but, there is no country that offers real stability as an alternative. China, in a dramatic move, reformed its constitution to give Xi Jinping an unprecedented third term - consolidating power in one man is not the sign of a healthy political system. Europe, which lacks a single political entity governing it, is victim to Brexit and the mismanagement of its smaller and less disciplined nations (think Greek debt-crisis of 2009).

When central banks fill their reserves, they do not do it in U.S. cash but instead mostly in U.S. treasury bonds. Treasury bonds are considered among the safest assets in the world, its yield is called the “risk-free rate” because it is the closest thing investors can imagine to having a zero-risk asset. The U.S. dollar has been on at least one side of 90% of international transactions for the last two decades - while its presence in reserves has dropped, it remains the unbeatable sure-way to do business around the world.

If reserves are a sign of trust, the world doesn’t trust China. As mentioned, the yuan remains less than 3% of global reserves. China, unlike any western country, maintains a closed capital account economy - meaning the CCP has high control over the movement of capital in and out of the country. The yuan, unlike the dollar, is fixed, not floating, meaning it is insulated from free market pressures. These mechanisms are put in place to protect the Chinese economy from external financial crises seeping in, but they ruin any chance of the yuan replacing the dollar. There is no sign that Chinese leaders will westernize this part of their economy any time soon.

In short, the U.S. dollar isn’t dying. The constant predictions on America’s demise is more of a pastime sport than reflections on reality. The world still looks to the U.S. as a source of trust and strength - and if we do lose that, it won’t be because China or some other country out-did us.

It’ll be because we messed it up ourselves.

food for thought,

shreyas sinha

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