Predictions over the US Dollar’s supposed demise as ultimate world reserve currency have made the rounds for decades. Time has always proved that such claims have been premature. The current ones making waves are unlikely to be any different. It is very much true that United States hegemony does appear to be diminishing but expectations that we are also embarking on a breakaway from USD hegemony is a completely different matter altogether.
The USD is still on one side of as much as 90% of all trades. If there was ever a fact point to spell out how dominant the Greenback is on world finance, that is it. Furthermore, even if the USD share of global fx reserves have gradually diminished, they remain substantially above the low of around 45% in the early 1960s. Even considering the gradual decline of USD reserves, it still accounts for around three times more than its nearest competitor, which is actually the Euro.
There are a number of factors behind why investors trust the USD as the world reserve currency. Contrary to what might be assumed, economic fundamentals such as the status of largest economy in the world are not necessarily a key parameter. Indeed, China is on many levels competing with the United States economically and will more likely than not soon be labelled as the largest world economy. Displacing Dollarisation is a separate matter.
When discussing topical subjects such as the international role of the US Dollar in world media, it is often not mentioned enough how critical elements such as trust in an asset as a store of value, size and depth of financial instruments available to investors, standardisation of capital markets and ease of accessing capital are to this debate. A trusted monetary policy framework and a clear structure of that economy’s political/social environment, such as freedom of the press, law and order, and democracy, are also necessary. These represent just a few of the criteria needed. In a nutshell, there is a precise yet complex and sophisticated system of governance, safety, and standardisation that entices investors to keep returning to the Dollar. Such framework and governance are not available elsewhere. It will also be challenging to create one.
This article does accept that from at least an international relations and economic diplomacy standpoint, we are already entering an increased multi-polar world. However, this is far from the case when it comes to financial supremacy. The United States does and will continue to reign supreme. Unless we see seismic shifts in investor behaviour, the USD stands at such a high base of sheer dominance that it might even take decades for the Dollar to be surpassed.
The main strength underpinning Dollar dominance by most accounts is that there are actually no alternatives.
The Euro has long settled for second world reserve currency status in the currency arena, while the British Pound has never recovered from the period where the USD hegemony commenced following World War II. For example, when Washington spectacularly humiliated London during the 1956 Suez Crisis. Washington famously pressured the IMF to deny financial assistance to the United Kingdom so that it would stand down in Egypt, in which is just one of the many examples of how the United States has been able to use its financial muscle to flex dominance in world affairs.
This article also agrees that the Chinese Yuan likely represents the strongest threat to Dollar dominance to date. Yet, data shows that the Yuan is coming from such a low base (for example China’s currency only represents minimal amounts of global fx reserves and SWIFT transfers) that it cannot even be considered as a competitor to the Greenback. The main target for China right now to even be seen as a real competitor to Washington’s global financial supremacy is to surpass the Euro as number two world reserve currency.
For the Yuan to compete with the Dollar on an international level, China would likely need to embrace sweeping reforms to increase investor confidence. Beijing is unlikely to consider such action. If anything, the current indications from the outside is that Beijing is curtailing power domestically rather than showing the outside world that it can embrace aspects such as free markets.
Just some of the potential reforms that would be needed to enhance the Yuan’s reputation on a world stage as a trusted asset of safety include in no particular order, freedom of press and speech, democracy, a free-floating foreign exchange rate, and a central bank that is independent to set monetary policy.
Hopes for such reforms are ambitious. Calls for China to open up capital markets and allow free-floating of the Chinese Yuan alone have been repeated for years.
All in all, when statements are made regarding the threat of De-Dollarisation we must be aware of the sophisticated framework that is in place to ensure the USD remains as ultimate reserve currency. Criticisms of the United States gradual diminishing status as the number one world economy and its impact on global affairs are warranted. However, Washington surrendering financial supremacy and its role as the number one world reserve currency are completely different matters.