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Threats to the US dollar’s role as global reserve currency

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From Maria Alejandra Madi and RWEA pedagogy Blog 2021 marked the 50th anniversary of the “weekend that changed the world”, when US President Richard Nixon suspended the convertibility of the dollar into gold. From a monetary point of view, since then there has been continued dominance of the dollar as a vehicle for international transactions. However, Is the dollar as the world’s reserve currency under attack? The dollar’s dominance in global markets is still significant, with its role in trade invoicing, international debt, and cross-border non-bank borrowing outstriping that of the US. This dominance has been attributed to the absence of alternatives, such as an inadequate supply of investment-grade government securities or limited liquidity and availability by regulation.

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from Maria Alejandra Madi and RWEA pedagogy Blog

2021 marked the 50th anniversary of the “weekend that changed the world”, when US President Richard Nixon suspended the convertibility of the dollar into gold. From a monetary point of view, since then there has been continued dominance of the dollar as a vehicle for international transactions. However, Is the dollar as the world’s reserve currency under attack?

The dollar’s dominance in global markets is still significant, with its role in trade invoicing, international debt, and cross-border non-bank borrowing outstriping that of the US. This dominance has been attributed to the absence of alternatives, such as an inadequate supply of investment-grade government securities or limited liquidity and availability by regulation.

Nevertheless, Barry Eichengreen and other researchers (FMI, WP/22/58, March 2022) argue that the share of reserves held in U.S. dollars by central banks dropped by 12 % since the turn of the century, from 71% in 1999 to 59% in 2021.The decline in the dollar’s share of global foreign exchange reserves is not due to changes in exchange rates, interest rate levels, or differentials, but rather due to active portfolio diversification by central bank reserve managers.

Indeed, the US dollar’s share in official reserve assets worldwide has fallen over the past two decades, with an increase in nontraditional reserve currencies such as the Australian dollar, Canadian dollar, Chinese renminbi, Korean won, Singapore dollar, and Swedish krona.

The global presence of nontraditional reserve currencies is illustrated in the table below. This is due to the following three factors:
• the growing liquidity of markets in these currencies,
• the advent of electronic trading platforms and automated market-making and liquidity management technologies,
• and the development of markets for trading currencies other than the Big Four.

Foreign Exchange Reserves in Nontraditional Currencies, end-2020: selected countries
   Reserves in nontraditional currencies (bil US$) Foreign exchange                                   Chinese             non-SDR             Share of reserves in reserves (bil US$)             Total               renminbi           currencies          nontraditional currencies
Total 8270.0 769.6 117.2 650.8 9%
Turkey 48.5 15.9 15.9 33%
Chile 37.8 10.6 3.1 7.6 28%
Russia 444.5 94.7 75.3 19.5 21%
New Zealand 12.0 2.1 2.1 17%
Australia 32.6 5.2 1.7 3.5 16%
Poland 138.5 20.8 0.0 20.8 15%
Spain 57.3 8.5 0.6 7.9 15%
South Africa 43.1 6.1 3.8 2.4 14%
Colombia 56.6 7.8 7.8 14%
Sweden 45.9 6.1 0.3 5.7 13%
Singapore 359.3 45.2 45.2 13%
France 57.1 7.0 0.0 7.0 12%
United Kingdom 182.6 19.8 0.5 19.3 11%
Italy 47.5 5.1 0.4 4.7 11%
Germany 36.9 3.6 0.3 3.3 10%
Switzerland 1013.2 97.5 10.2 87.4 10%
India 465.8 44.8 44.8 10%
Norway 71.6 5.4 0.3 5.1 7%
Korea 431.3 28.3 28.3 7%
China 3216.0 198.4 0.0 198.4 6%
Mexico 184.2 9.2 3.3 5.9 5%
Brazil 336.9 16.8 10.8 5.9 5%
Sources: IMF Reserve Data Template and central banks Note: Foreign exchange reserves do not include monetary gold, SDR holdings, and reserve position in the IMF. The data are as of end-Jun 2020 for India, end-Mar 2021 for South Africa, and end-Jun 2021 for Brazil, Kenya and Tanzania. Apud The Stealth Erosion of Dollar Dominance: Active Diversifiers and the Rise of Nontraditional Reserve Currencies. Serkan Arslanalp, Barry Eichengreen, and Chima Simpson-Bell. FMI, WP/22/58, março 2022

When data from 80 different central banks is considered for the time period between 1999 and 2020, the emergence of alternative reserve currencies shows a huge increase, going from approximately $30 billion in 1999 to $1.2 trillion in the last two decades.

Barry Eichengreen and other researchers show that:
• the size of the reserve issuer’s economy has become less important in recent years, and inertia in currency shares may have been overestimated in previous work.
• as advanced country governments and emerging markets have moved away from issuing debt in dollars, central banks are less compelled to hold dollar reserves.
• as the US accounted for a declining share of global trade, this has also affected the global reserves composition
• the fact that major central banks lowered interest rates in response to the 2008 global financial crisis also helped this change in the new composition global reserves.

There is a great deal of conjecture and speculation on the future supremacy of the dollar since there exist various factors that pose potential risks to the worldwide reserve currency status of the United States dollar. The following are some ideas, topics and concerns that should be thoroughly discussed by students:

• Barry Eichengreen believes that the current state of competition between international currencies does not seem to be a battle between “major currencies”. He suggests that the end of the dollar’s dominance may be the result of the rise of a broad group of alternative currencies.

• Michel Petty states that the end of the US dollar’s dominance or its partial replacement by the Chinese currency requires major changes in China’s financial markets and monetary policies (e.g. the end to current account and capital controls). Will the central bank of China take steps in this direction?

• According to the Global Diplomatic Forum, BRICS members are building payment infrastructures for international transactions. In addition to the prospect of a BRICS cryptocurrency, its members have been developing central bank digital currencies. Will this contribute to further de-dollarisation of global reserves?

• Jean-Pierre Landau argues that it is possible that in the near future, the demand for reserves as secure and easily convertible assets for precautionary purposes may become more significant than the demand for reserves as a medium of international exchange. This shift in demand might potentially lead to a greater reduction in the reliance on the US dollar as the dominant currency for global reserves. In this context, it is worth considering the potential implications of the digitalization of public and private currencies on the management of international reserves.

• According to Thomas Pallley, the concept of dollar hegemony can be understood as a phenomena rooted in the United States’ significant international economic, military, and political influence. The establishment of the dollar’s hegemony at the Bretton Woods conference was primarily rooted in the United States’ prevailing commercial and manufacturing power. However, the present-day hegemony of the dollar is primarily underpinned by a financial model that has become increasingly globalised.

Therefore, a decisive question stands as to what the future holds for the United States dollar’s preeminence amidst the intricate economic, political and military challenges that are oresent on the international stage?

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