Gabriel Bo, Stanford University
The US dollar (USD) has been the default global reserve currency since the end of World War II, meaning most countries see the dollar as a safe investment and typically keep it in their coffers to conduct trade. At its highest, more than 71% of the world’s central bank reserves utilized dollar assets—that number has dropped to 59% today, but it still remains unrivaled.
However, when experts like Lynette Zang, a chief market analyst for ITM Trading, caution that the US dollar’s “longstanding dominance is on shaky ground,” it gives Americans anxiety that they are losing what they gained after WWII. “It isn’t just the death of the dollar. It’s the death of the entire financial, monetary and social system,” explains Zang. The USD’s demise has never seemed more realistic—and more distressing. JPMorgan, America’s biggest bank, had strategists Meera Chandan and Octavia Popescu warn of the dollar’s waning influence in the global community. Additionally, early last year, House Representative Emmer (R-MN 6th District) proposed a bill that blocks the creation of a central bank digital currency (CBDC) that would take attention away from the USD and shift it toward different alternatives.
Why is a strong dollar vital?
Since most international transactions are settled using the dollar, most countries need to keep the USD in order to make purchases. Countries trust that the dollar won’t lose value, thereby giving this fiat token some inherent fiscal value.
Why has dollar dominance remained so sticky (i.e., consistently strong in the eyes of global investors)?
The dollar has a few inherently desirable features. Principally, it is highly stable, liquid, safe, and convertible. Despite America’s inflationary uncertainties, US securities have continued to boom. Morningstar US Core Bond Index, a proxy for the broader bond market, increased 2.77% over the course of 2023. Making it easy to purchase US bonds enables the US to increase demand for the greenback, leading to a stronger dollar as investors need to purchase dollars to buy these bonds. Beyond being an excellent medium of exchange, the dollar’s dominance is also tied to the strength of US financial markets. American banks are by far the largest, deepest, and most liquid in the world, offering an abundance of attractive dollar-denominated assets foreign investors can trade. Yet over a period of just two days in March 2023, banks like Silicon Valley Bank (SVB), Signature Bank, and First Republic Bank went from “solvent to broke as depositors rushed to SVB to withdraw their funds.” But despite some financial tragedies, the Federal Reserve’s monetary policy has continued to be transparent and objective, helping steer the nation in the right direction. To traders around the world, US economic, political, and institutional fundamentals inspire credibility and confidence, enough for them to keep using the dollar for nearly a century.
Even after the dollar’s near-twilight in 2009, it emerged just as strong. In response to the Great Recession, the Federal Reserve drastically lowered interest rates to stimulate the economy. Lower interest rates generally make a currency less attractive to foreign investors, as they reduce the returns on investments denominated in that currency. Nevertheless, America came out on top. Compared to the rest of the world—even with competitors like Japan’s Yen and China’s Yuan gaining traction—the USD still maintains at least $12 trillion dollars of the international money supply, more than 60% of the global supply.
Who is challenging the USD for global dominance?
In recent years, there have been several challengers of the dollar. As mentioned by the Council on Foreign Relations, “high global demand for dollars allows the United States to borrow money at a lower cost and use currency as a tool of diplomacy.” Yet this power has been misplaced, with “extensive US sanctions [driving] some countries to transact in other currencies, raising fears of ‘de-Dollarization.’”
Enemies and even weaker allies of the US have begun to gain “de-Dollarization” momentum across various countries and regions.
Russia and China have been particularly active in this arena. Since the West levied sanctions against Russia following its invasion of Ukraine, there has been a significant increase in ruble-yuan trade, illustrating a concerted effort to reduce reliance on the dollar. This move is also supported by the purchase of gold by central banks, especially in Russia and China, as they diversify their reserves away from the dollar.
Brazil and Argentina are discussing the creation of a common currency for the two largest economies in South America, signaling a shift away from the dollar in regional trade. Similarly, other South American countries like Bolivia are starting to conduct trade using the Chinese Renminbi (RMB), further indicating a trend toward de-Dollarization.
In Asia, China’s push to internationalize its currency, the Renminbi, has seen mixed results. While about 20% of China’s trade is settled in its own currency, the majority is still conducted in dollars. The slow adoption of the Renminbi as an international currency is attributed to its non-convertibility and China’s closed capital account policy, alongside geopolitical factors that may deter foreign firms from holding assets in RMB.
The proposal by China and Malaysia to establish an Asian Monetary Fund (AMF) is another step toward reducing Asia’s dependence on the dollar. Indonesia, in particular, has been advocating for concrete policies like the use of local currency settlements (LCS) in trade transactions and has established LCS agreements with several countries, including Thailand, Malaysia, Japan, China, and South Korea.
The BRICS nations (Brazil, Russia, India, China, and South Africa) are also exploring the creation of a new reserve currency to reduce reliance on the US dollar in international trade and finance. At an April 2023 BRICS summit, newly-elected Brazilian president Luiz Inácio Lula da Silva asked, “Why can’t we do trade based on our own currencies?”
Given these trends of countries seeking to diversify their currency usage, it’s easy to see why American politicians, lenders, credit card users, and citizens might be worried of dwindling dollar dependency. This shift, while gradual, is driving many economists to panic: Could this mark the end of American hegemony? However, these reactions may be over-exaggerated. Whether it be the dollar’s long standing reign, its unprecedented liquidity, or its unattainable stability, no other currency has been able to outpace the US for decades, let alone even enter the money race with them. Regardless of growing foreign agreements to divert from the dollar, there seems to be no prince that can dethrone King Benjamin.
Can a dollar coup d’etat succeed?
When a currency slips, there tends to be another currency waiting to replace it. For instance, the USD and British pound were neck-and-neck before the pound ceded its place as the default reserve currency to the dollar. Yet today, no currencies challenge the USD. Potential rivals like the Chinese Renminbi (RMB), the Euro, and various cryptocurrencies all face distinct challenges that hinder their potential to supplant the US dollar as the dominant global reserve currency.
Renminbi (RMB) or Yuan
The People’s Bank of China, China’s central bank, lacks the transparency often seen in other major central banks. Furthermore, Chinese banks do not operate independently of government decisions. Of course, the state’s stranglehold over the currency has deterred investors.
Moreover, utilizing the RMB carries geopolitical risks, particularly for nations that are not closely aligned with China. Especially in contrast with the dollar, which is seen as a safe haven for investors to park their money, the RMB’s appeal is limited by the Chinese government’s aggressive foreign policy.
Euro
The Euro, despite being the currency of one of the world’s largest economic blocs, faces several structural and institutional challenges.
The Eurozone’s fragmentation limits the Euro’s potential as a global currency because it hinders the European Union’s ability to respond uniformly to financial crises and manage fiscal policy efficiently.
Additionally, until recently, the European Union did not extensively sell its debts in the form of bonds or government treasuries. This limited the EU’s capacity to raise capital and loan money, essential functions for a currency aspiring to reach reserve status. Without robust and widely-recognized debt instruments, the Euro’s appeal as a reserve currency is constrained.
Cryptocurrencies
Cryptocurrencies, despite their growing popularity, face fundamental issues that prevent them from becoming viable global reserve currencies. For one, cryptocurrencies like Bitcoin are seen as speculative assets with no intrinsic or legislated value. They are highly volatile and subject to the whims of the market, making them unreliable as a store of value or medium of exchange.
Moreover, the collapse of major cryptocurrency exchanges and platforms, such as FTX, has highlighted the risks associated with the cryptocurrency market. These incidents underscore the sector’s instability and reinforce the perception that cryptocurrencies are not yet mature or stable enough to function as global reserve currencies.
Conclusion
American supremacy has been on the decline for decades. From China’s growing influence fueled by the Belt and Road Initiative to the Global South’s independence in state-building, America’s time hogging the spotlight appears to be coming to a close. The United States is no longer a sole empire, but there are still relics of its reign. China, Russia, Brazil, India, and Europe are on the rise, and their attacks on the dollar won’t cease.
The global financial landscape made it perfect for the US to transition from an era of war to an age of unchallenged innovation. Thanks to the US dollar’s resilience and its entrenched position as the world’s primary reserve currency, America’s period of dominance lasted longer than expected. Despite the Cold War and the Great Recession, the robustness of the US financial system continued to prevail. Fast forward to today, and the dollar still stands without peers. Attempts to dethrone the dollar by BRICS nations are mainly intended to challenge the US as a global superpower rather than to put forward a better foreign reserve currency alternative. So as the economy continues to evolve today—from blockchain-based digital currencies to the purposefully-deflated Yuan—foreign coffers still can’t leave out one thing: the US dollar.