A Complete Overview: Will USD Continue to be the Global Reserve Currency?

USD has been the global reserve currency for decades. Will this trend continue, or will innovative technologies and other nations catch up to the United States?

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For decades the U.S. dollar has been the world’s dominant currency. Nearly 60% of the world’s foreign exchange reserves are in dollars, but that share has begun falling gradually over this past year. Many globally consider the US dollar to have been playing an “outsized role” in global markets; however, this is beginning to change as the American economy has been producing a shrinking share of overall global output over the last couple of decades. The evolution of crypto markets, foreign markets, and technology has weakened the dollar’s market share in international payments and the global economy. Countries like China, India, and the European Union have risen up the world superpower rankings and command a greater presence and influence over the world economy than ever before. Is the U.S. dollar’s primacy at risk? Will the rise of central bank digital currencies, cryptocurrencies, and other innovations quicken the dollar’s decline? Will U.S. sanctions on Russia’s reserves lead other countries to put their reserves in other currencies? And importantly, what might be the macroeconomic impact on the U.S. if the dollar were to lose substantial market share?

Does the rise of CBDCs, cryptocurrencies, and other innovations pose a threat to the dollar?

Bitcoin has been championed as a store of value that can be used to hedge against inflation or the debasement of fiat currencies like the dollar. Some have touted it as “digital gold.” Bitcoin and other cryptocurrencies also present themselves as a way to buy goods and services like actual money in a decentralized manner, away from the centralization of the government.

Ethereum, the second most popular cryptocurrency after Bitcoin, has even more uses as it is built to be a decentralized computing network. Many smaller cryptocurrencies are using Ethereum’s network to further disrupt the crypto industry. All transactions are decentralized and public ledger that is verified and recorded on the blockchain. This means that it is not managed by any centralized entity; instead, all investors have identical copies of the public ledgers, letting them see all past transactions. This means government involvement will be limited; more regulations may take place in the future; however, the government will not be involved in the printing, distribution, or control of money, giving the power back to the people.

To regain some sense of control over the digital asset market, the United States and many other nations are developing their own central bank digital currency. This could potentially increase payment efficiency and lower transaction costs. However, CBDCs are the opposite of other cryptocurrencies because it is centralized, issued, and regulated by the government. This could potentially have a more significant impact on USD because CBDCs are backed by the full faith and credit of a centralized government, providing less volatility to its currency. This currency will be used less as an asset for the typical investor but more as a store of value and a medium of exchange between multiple parties as long as it is able to hold its value with as much stability as the U.S. dollar currently holds.

CBDCs and cryptocurrencies like Bitcoin and Ethereum will become increasingly relevant as means of payment and as an alternative asset; however, the consensus is that they are unlikely to displace the US dollar. For Bitcoin to be considered fiat, a viable legal tender, it should, at a minimum, be useful as a medium of exchange (i.e. a means of payment), store of value (i.e. the value of Bitcoin should hold its value over time) and unit of account. Although Bitcoin is increasingly used as a medium of exchange, it is highly debatable whether it will ever function strongly enough as a store of value and unit of account given its highly volatile nature. Stability is needed to be used as a daily currency or even as a tender for international trade. Because Bitcoin and other cryptocurrencies are not backed by any physical assets, we may never see proper stability like we do with the U.S. dollar. On top of that, Bitcoin also faces stiff competition from central banks and countries that would be highly reluctant to forgo their dominant positions as issuers of fiat money. For those reasons, Bitcoin and other cryptocurrencies will most likely never pose a true threat to the dollar.

How does the Russia-Ukraine conflict, and the fall of the Euro, affect the dollar and other global currencies?

Global geopolitical risks have soared since Russia’s invasion of Ukraine. Investors, market participants, and policymakers expect that the war will exert a drag on the global economy while pushing up inflation, with a sharp increase in uncertainty and risks. Some of the already seen effects of this war include food and fuel shortages and an acceleration of inflation. Not only that, but the war has rattled investors, plummeting almost all sectors of the stock market into a downward spiral. While this outcome was guaranteed to eventually happen due to the significant increase in printed currency throughout covid, the war certainly helped accelerate the process.

With a war waging in Europe, an uncertain energy supply from Russia, and a growing recession risk, the Euro could not handle the pressure and dropped, hitting parity with the U.S. dollar. This one-to-one exchange rate has not been seen in over 20 years.

With the United States having more buying power over the Euro, European goods and exports are cheaper than ever before, at least in the past couple of decades. In turn, U.S. imports would rise due to more affordable European products. U.S. goods will also become more expensive to other nations as U.S. exports fall due to the increase in price. However, due to the impending recession concerns and the downturn in the market, the U.S. and the entire global economy have less financial spending power; therefore, the standard currency appreciation and stabilization process might not happen in the standard way. Due to these very legit concerns, we might see an overall downward trend in exports and imports in the U.S. rather than an inverse trend that is usually shown.

However, one thing is for certain; this radical economic outlook gives yet another incentive for European and global investors to invest in USD, especially with how much better it is doing over the Euro. During times of impending or imminent recession, foreign investors looking to invest into USD as it is considered the most stable and secure currency in the world. The war in Ukraine, alongside the Euro hitting parity with the dollar, makes this reality even more evident.

Does the Chinese Digital Yuan have a Chance in Overcoming the U.S. Dollar?

China’s digital yuan (CNY) is set to challenge the dollar’s domination of international trade in the upcoming decade.

“Remember, China is the largest trading country and you’re going to see digital yuan slowly supplant the dollar when buying things from China,” according to Richard Turrin, author of “Cashless: China’s Digital Currency Revolution.

China has been ramping up efforts to roll out its central bank digital currency and is currently far ahead in the space compared with its global peers and even the United States. Turin said the world’s second-largest economy is currently “ahead in all financial technology by a decade.” He added the U.S. would take “easily another five years” just to get out of planning and trials for a potential digital dollar.

However, while the potential is certainly there, the U.S. dollar has too big of a foothold in the global economy for China to unseat it as the #1 global reserve currency. The U.S. dollar currently makes up 51% of central bank reserves, while the CNY makes up 2%. Likewise, the U.S. dollar is involved in 88% of global F.X. transactions, a figure that has remained stable for the last two decades despite China’s meteoric growth, while the CNY is involved in only 2% of global F.X. trades. Its exposure into the foreign exchange market is expanding, but not at a pace that can compete with the United States any time soon.

Currently, the currency is having its worst month ever, hitting the lowest levels since September 2020. The currency has lost around 7% of its value against the dollar in the past three months. While China is currently the second-largest economy in the world and a key driver of global growth, its digital yuan is nowhere near the level of compensating for its weight in China’s economy. Currently, China’s government and corporate debt securities markets are quite large but still seen as having limited trading volume and weak regulatory frameworks. Strengthening its financial markets would be necessary for China’s own economic development and for promoting the international use of its currency.

History suggests that a country seeking “reserve currency” status must have a sound institutional framework. This includes an independent judiciary, an open and transparent government with institutionalized checks and balances, robust public institutions, and a credible central bank, free from heavy currency manipulation. These elements have traditionally been seen as vital for earning the trust of foreign investors, both private as well as official, including central banks and sovereign wealth funds. China currently operates as a private socialist economy that does not promote free and minimally regulated trade like the United States capitalist model. This one-party system helps with the nation’s legislation, allowing China to get laws and regulations approved faster than in a two-party system. This enables China to stream past the United States in many technological aspects as they do not need to deliberate an idea for months before applying resources to get it done. However, the complete socialist control of the Chinese economy will continue to draw red flags from investors. In order for China to reach this reserve currency status, it would have to drastically loosen its grip on the economy and deploy a more capitalist system.

What would be the macroeconomic impact if the US dollar were to lose its hold on the global economy?

Many investors believe it would be better for the global economy to have a more balanced international reserve system that relies less on any single currency. But the process of getting to this point would be a bumpy one, and it would have significant implications for both exchange rates and the cost of capital in different economies.

For the US, giving up reserve-currency status may help the country balance its trade relationships, but it would likely hurt the value of the dollar and create an inflationary pressure on the prices of consumer goods.

If the US dollar were to lose its reserve status, investors should anticipate a drop in the dollar’s exchange rate, a negative effect on US interest rates, and potential underperformance for US equities and fixed income. Currently, the United States is able to keep international transactions running smoothly and transaction costs low due to its stability in USD price. With more foreign countries using the currency and even investing in it, liquidy is boosted and financial assets can be priced more easily. The United States is also able to export its debt, offering US Treasury bonds for foreign countries to purchase which brings great benefit to the U.S. This then transitions to more available and easily provided loans, letting US companies get easier access to capital because of the dollar’s reserve status.

According to the Federal Reserve, the dollar is used in 40% of global trade transactions. When it comes to global cross-border transactions, the dollar dominates, being used around 80% of the time. Countries demand U.S dollars due to alot of reasons. International trade and commodities like crude oil are priced in dollars which means that commodity imports must be paid with dollars. Many countries issue debt in dollars. By borrowing in dollars, these countries can pay a lower interest rate on their debt because investors don’t need to worry about currency risk. On top of that foreign central banks hold a lot of dollars in U.S. Treasuries which increases the attractiveness of the U.S. dollar to other countries. Without that reserve status, this process could easily be changed or hindered. The dollar would be used less, declining the U.S global economic activity.

Will the U.S. Dollar Lose Its Reserve Status?

To conclude I believe that the U.S. dollar may have the potential to lose its status as a global reserve to competing nations such as China, or to cryptocurrencies such as Bitcoin or Ethereum. However, ultimately the U.S. dollar has such a big foothold in the global economy that these threats do not pose it any real danger. About 60% of the $12.8 trillion in global currency reserves are currently held in dollars, giving the US an exorbitant privilege over other countries. Countries like China are still in the very early stages to create their own digital currencies that could have real-life use cases. Even when these CBDCs or digital currencies become fully operational, investors will remain hesitant to operate in this landscape due to China’s political nature. Some western and Asian countries may take full advantage of China’s digital yuan, but European and American investors will stay clear from that market. As for other cryptocurrencies like Bitcoin or Ethereum, they are just too volatile to be used as a dominant legal tender in their current stages. Even with increasing innovation, the first half of 2022 has taught us that crypto remains to be as volatile as it has ever been. Investing in these concepts is one thing, but using them as actual currencies is a whole other matter entirely.

While the U.S. dollar may lose some of its value and buying power over the next couple of decades, it will surely remain as the single most dominant currency on the planet for years to come, even with countries like China, and new innovations in crypto technology creeping forward in its attempt to catch up.

Experts Opinions:

• “We tend to think that nothing could ever dislodge the dollar from this preeminent status as the world’s currency,” said Stephen Roach, a senior fellow at Yale’s Jackson Institute for Global Affairs. “I think that view is overblown and ultimately will be challenged.”

• “I think the chances of that happening in my lifetime are negligible,” said Kathy Jones, managing director at Schwab Center for Financial Research. “When we’ve seen concerns about events in the global economy, whether it’s the economy or geopolitical events, the dollar has gone up, not down. It’s seen as a safe haven.”

• “A dollar collapse actually is quite unlikely because the implication of a dollar collapse is that you would have a real search for safety,” argued Eswar Prasad, a senior fellow at the Brookings Institution. “And the only really safe place to put lots of money remains the U.S.”

• "What we are seeing is the battle for second-place status possibly intensifying while the dollar's role remains dominant," said Cornell University Professor Eswar Prasad.