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Is U.S. Dollar At Risk Of Losing Reserve Currency Status?

By James PicernoForexJun 04, 2021 12:57PM ET
www.investing.com/analysis/is-us-dollar-at-risk-of-losing-reserve-currency-status-200584300
Is U.S. Dollar At Risk Of Losing Reserve Currency Status?
By James Picerno   |  Jun 04, 2021 12:57PM ET
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U.S. dollar weakness is a topical subject this year, inspiring new forecasts that the currency is in danger of losing its reserve currency status. Advocates of this outlook point to various clues that suggest the end is near. But a careful review of the likely replacements suggest that the greenback will retain is central role in world trade for years to come.

That’s not to say that near-term factors won’t weigh on the buck or that the U.S. dollar’s position as the world’s reserve currency is permanent. Given a long enough time frame, it’s plausible, perhaps even inevitable, that the U.S. dollar-centric global economy that’s prevailed post-World War II will give way to something else. But getting from here to there will take time, probably decades. Meanwhile, the dollar’s position as the reserve currency remains secure, albeit battered and bruised relative to post-war history.

Recent estimates find that roughly 60% of central bank reserves are held in U.S. dollars. That’s down from previous decades and will likely slip further in the years ahead. But a rapid decline in the short run is unlikely, in part because the alternatives to the buck aren’t particularly attractive for a variety of reasons.

Source: crsreports.congress.gov

I briefly discussed the subject in a podcast earlier this week at The Milwaukee Company and it’s worth developing some of my talking points in more detail. Let’s focus on the would-be replacements to the U.S. dollar as a reserve currency.

China: The economic rise of the country over the past 40 years suggests that the U.S. dollar will hand off the baton to the yuan, echoing the shift from the British pound to the greenback during the first half of the 20th century. But unlike the former changing of the guard, China’s currency isn’t ready for prime time as a reserve currency.

There are several reasons why the yuan isn’t set to displace the dollar as the world’s primary reserve currency. Perhaps the leading factor: China has yet to allow free trade of its currency and substantially reduce or eliminate the peg to the greenback. China also restricts capital flows in and out of the country, which is a non-starter for a reserve currency in the eyes of most institutional investors. Other impediments to the yuan’s rise as a true reserve currency include a lack of transparency in China’s financial markets on par with the U.S. A distinct lack of clarity and transparency for China’s monetary policies is another challenge.

In time, these and other obstacles may be resolved. But the day when the People’s Bank of China attains the respect and trust akin to the Federal Reserve, the European Central Bank, the Bank of England and others, the prospect for a yuan-led world for the global trading system will remain a distant scenario.

Eurozone: The euro was designed, in part, to be an heir to the dollar’s throne, but the plan ran aground several years ago. True, the euro is the world’s second-most commonly held reserve currency after the dollar, but the days when currency strategists predicted it would soon rise to the top of the mountain are long gone. A key reason is the internal political risk in the Eurozone, which creates the perception that instability is forever lurking. Although the 19-country currency bloc appears intact for the moment, events in recent years highlight the embedded risks that reside in an economy linked by a single currency without the equivalent on the fiscal and financial fronts. Disparate political systems only increase the tension and raise doubts about the euro’s durability in the long run. These and related issues came to the fore following the Eurozone’s sovereign debt crisis in 2011, which triggered fears that highly-indebted countries such as Greece might leave the euro. The bottom line: the Eurozone in its present form is poorly designed to handle financial shocks — a limitation that (unless it’s resolved) will likely keep the euro as a perennial also-ran in the world-reserve currency race.

Japan and the United Kingdom: The yen and the pound are forever on the short list of lesser players for currency reserves, but for various reasons neither is likely to displace the dollar. The yen has long benefitted from its status as a relatively safe haven in Asia, supported by Japan’s economy, which is currently the world’s third largest after the U.S. and China. But Japan’s ongoing challenges, including a rapidly aging population, perennially slow growth and other factors, all but ensure that the yen will remain a consistent but marginal player as a reserve currency. Meanwhile, the slow but persistent fade of the UK from the world stage (relative to its peak more than a century ago) strongly suggest that the pound is unlikely to regain its former reserve-currency status.

Cryptocurrencies: There are fanciful discussions in some corners about replacing fiat currencies with Bitcoin, Ethereum and other digital currencies. But the odds of this happening anytime soon are virtually nil. There’s a laundry list of reasons, but we can start with the volatility. The risk of massive moves in value over the short term is a deal killer for putting more than a trivial amount of a country’s reserves into crypto. The same risk derails the prospect for using crypto for international transactions. As a thought experiment, imagine the self-inflicted risk that would arise by routinely booking international trade in bitcoin instead of the dollar. The potential for huge, sudden losses in an otherwise profitable dollar-based international transaction will keep crypto on the far margins for reserve currency status.

Gold: Everyone’s favorite precious metal has for centuries been the obvious choice for diversifying away from whatever fiat currency at the top of its game. But gold remains a bit player for reserves, although some countries have been beefing up holdings in recent years. Perhaps some macro catalyst could change perceptions about the metal. But if the various bouts of economic turmoil over the past generation haven’t already unleashed a rush to gold, that’s a pretty good sign that displacing fiat currencies with the barbarous relic remains a low-probability event.

The bottom line: The dollar’s status as the premier reserve currency is precarious, and will remain so, probably for as far as the eye can see. But in order for the dollar to fall from its perch there must be a replacement. China’s currency is in the strongest position to inherit the mantle, but structural and political issues will likely keep the yuan nipping at the dollar’s heels for years, perhaps decades, without taking the crown.

A more likely scenario is that reserve currency holdings continue to diversify at the expense of the dollar. But this trend will be gradual and at times imperceptible. The dollar will likely remain the worst choice as a reserve currency… except when compared with everything else.

Is U.S. Dollar At Risk Of Losing Reserve Currency Status?
 

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Is U.S. Dollar At Risk Of Losing Reserve Currency Status?

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Comments (8)
Miles Mathewson
Miles Mathewson Jun 06, 2021 12:26PM ET
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No doubt, There's no viable alternative at the moment. Cryptos are the closest but the anarchy that the crypto market has become that will be impossible. Just buy the USD dip and be happy !
MK MK
MK MK Jun 05, 2021 4:24PM ET
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You forgot to write: article sponsored by ugly yankies. Just keep giving us real goods instead of worthless green toilet paper
Ad Cline
Ad Cline Jun 05, 2021 4:24PM ET
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ok mmk...you don't like that "worthless green toilet paper". tell you what, I'll take what ever amount you have off your hands.
Robert West
Robert West Jun 05, 2021 3:12PM ET
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Do something productive, leave the $ alone!
Water Bender
Water Bender Jun 05, 2021 1:10PM ET
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Nothing is a given The Dutch had the reserve currency, then the French, then the British. The USA since 1944 has had the reserve currency, the year the IMF was formed. I always think of the Weimar Republic in Germany in the early 1920's. Germans using paper money to heat their Ben Franklin stoves to keep warm. Money is only paper and only worth the value we assign to it.
Colonel Forbin
Colonel Forbin Jun 05, 2021 1:10PM ET
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But the weimer republic wasn’t the reserve so just say you don’t know from ypur historical research . Either print snd manage the interest rates or Yuan is the reserve but your weimer comparison shows you are almost there but don’t quite understand whats going on. You sir , are a chat room hero !
William Cho
William Cho Jun 05, 2021 11:38AM ET
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armed cinflict and uprising in the usa would change everything.
Kaveh Sun
Kaveh Sun Jun 05, 2021 2:25AM ET
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Doesnt matter how much usa print, in war areas people keep, use usd. That wont change. InterTransactions r done mostly in usd too, example: transaction between private companies in mexico and China are mostly done in usd.
Emanuel Dabah
Emanuel Dabah Jun 05, 2021 2:25AM ET
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Well this is the neo economy theory , i must say I dont agree , every thing has a limit..... and outcome ....
Kaveh Sun
Kaveh Sun Jun 05, 2021 2:16AM ET
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The author forget about the people. Usd is accepted everywhere. If a gov is overthrown, their old money is wothless. Therefore, in those unstable areas, people keep usd.
Marry James
Marry James Jun 05, 2021 2:16AM ET
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hello
Emanuel Dabah
Emanuel Dabah Jun 04, 2021 5:21PM ET
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when you print Trillion of Trilion u are doing it worthless .... the effect of keeping the market alive at any price will break the confidence of other countries in the dollar, I own Gold since 2008 .... and keeping buying in the deep ...  this new patent of solving problems by printing is like you try to get out from the hole by pushing your hair.....   well the worst is about to come and it will be very ugly ... I don't talk about market collapse, I am warning of systems collapse the end of era that will put in shadow many turbulent eras in human history  good luck
Marry James
Marry James Jun 04, 2021 5:21PM ET
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hello
Marry James
Marry James Jun 04, 2021 5:21PM ET
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how are you doing
 
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