As far back as 1971, during the Nixon administration, the US Treasury Secretary John Connally shocked the world when, after discussions with a group of European finance ministers, he famously remarked, “The dollar is our currency, but it's your problem.”
Since the Second World War the US Dollar has been the unchallenged global reserve currency, used for nearly all international trade, and the preferred asset for countries, individuals and companies as a store of wealth. However, with so much of the global economy reshaping itself in the post-pandemic landscape, is the reserve status of the US Dollar going to be the next domino to fall?
Having the world's reserve currency has allowed the US to run large deficits in terms of both international trade and government spending. In 2023 the US deficit was a staggering $2 trillion and this level of deficits looks likely to continue. If foreigners no longer want to hold dollars for savings, the US government could face a severe funding crisis.
One of the financial trends that has gained traction over the past few years is the de-dollarization movement. This is an effort by a growing number of countries to reduce the role of the US Dollar in international trade. Countries like India, China, Brazil, and Saudi Arabia among others, are setting up trade channels using currencies other than the almighty Dollar.
If foreigners no longer want to hold US Dollars for savings, the US government could face a severe funding crisis.
The chart below shows China’s holdings of US Treasuries falling steadily since 2014, which is in line with a broader trend of foreign central banks buying less US government debt. Ten years ago, roughly 45% of US treasuries were held by foreign governments, and this has now fallen to below 30%.
China’s holdings of US Treasury Securities
Over the past several years the US has increasingly “weaponized” the US Dollar by imposing sanctions on countries that it disagreed with, and restricting access to the US controlled global foreign exchange markets. When Russia invaded Ukraine in 2022, the US imposed all-encompassing sanctions against Russia, and froze its foreign reserves. This action has forced many countries to ponder what could happen to their precious foreign reserves if they ever faced a diplomatic or military dispute with the US.
Can the US really just freeze our foreign reserves?
Geopolitics isn't the only issue, however. Inflation and government debt levels are also weakening the standing of the dollar on the international stage. Since the 1980s, the US maintained a low and steady inflation rate, and low debt levels, giving savers around the world the confidence to hold their assets in dollars. In recent years, however, US debt levels have soared to previously unimaginable levels, and together with a resurgence in inflation, this is calling into question the security and stability of the dollar for long-term savings.
Central banks are increasingly turning to gold as an alternative store of value. Gold, the most ancient widely accepted international currency, has chipped away at some of the dollar's dominance, accounting for 15% of reserves, up from 11% six years ago.
Central banks are increasingly turning to gold as an alternative store of value
Emerging market countries such as Singapore, Turkey, India, Poland and China have been among the largest buyers of gold over the last decade. Two successive years of over 1,000 tons of buying is testament to the recent strength in government demand for gold. Central banks have been consistent net buyers on an annual basis since 2010, accumulating over 7,800 tons in that time, of which more than a quarter was bought in the last two years. Findings from the Central Bank Gold Survey show that gold’s performance during times of crisis and its role as a long term store of value are key reasons for countries to hold gold.
As the world moves to the age of multipolarity where many nations participate in helping define the economic character of the global economy, trade in currencies other than the US Dollar is accelerating. And much to the chagrin of the US – which saw the US Dollar-based New York Clearing House mechanism as an irreplaceable link in the chain of most global trade – countries are finding that bypassing the US Dollar is surprisingly easy to do. And, what’s more, it is often cheaper too.
Our attention is usually on the developed Western economies which are the wealthiest by most measures. As an illustration of this, the US alone currently makes up nearly 70% of the MSCI World Index for equities. However, trade reflects altogether different realities and is perhaps best captured in the statistic that in 2022 China exported goods and services valued at $3.6 trillion compared to $2.2 trillion by the US.
The economies of India, China and the rest of Asia and the Middle East are larger and growing much faster than the US and the G7. This is starting to be felt in the de-dollarisation of trade.
Countries are finding that bypassing the US Dollar is surprisingly easy to do.
It is important to realise that reserve status is something that, historically, has been gained or lost over long periods. It's unlikely that the world will wake up one day with US Dollars no longer holding international appeal. Rather, in examples such as the British pound, there was a multi-decade process by which it went from the centre of world economics to a second-tier currency.
That said, if the US Dollar gradually loses its place atop the world financial pyramid, it would likely mean for the US, less access to capital, higher borrowing costs and lower stock market values. Having the world's reserve currency was described by the French Finance Minister in the 1960’s as an “exorbitant privilege” and has allowed the US to run massive deficits in terms of both international trade and government spending. This exorbitant privilege may be coming to an end.
Sources: Bloomberg, Wall Street Journal, Dr Michael Power.
