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Is the U.S. Dollar Still the Dominant Currency?

Vladislav Reshetnyak (Pexels)

Is the U.S. Dollar Slipping as the Dominant Currency?

 

The U.S. dollar has been the world’s dominant currency since the end of World War II.

According to the Congressional Research Service, roughly half of international trade, international loans, and global debt securities are denominated in $USD. The same goes for many of the world’s most traded commodities including gold, silver, and crude oil. In the chart below the Visual Capitalist has created a visual depiction that shows the standing of the U.S. dollar.

 

Graphics and information in this article provided by The Visual Capitalist and New York Life Investments

 

Top Traded Currency Pairs

The foreign exchange market is the largest financial market in the world, with an average daily trading volume of almost $7 trillion. The majority of this volume is driven by banks, corporations, and other financial institutions.

More than 70% of this volume is generated from the top seven currency pairs, all of which include the U.S. dollar.


Currency Pair Share of Global Transactions
EUR/USD 27%
USD/JPY 13%
GBP/USD 11%
AUD/USD 6%
USD/CAD 5%
USD/CHF 5%
NZD/USD 4%
EUR/JPY 4%
GBP/JPY 4%
Other 21%


The EUR/USD pair is the world’s most traded currency pair and is commonly referred to as “fiber”. It indicates how many U.S. dollars are needed to purchase one euro.


Foreign Exchange Reserves by Currency

Central banks typically hold foreign exchange reserves for purposes such as:

  • Influencing exchange rates
  • Maintaining liquidity in the event of a crisis
  • Backing debt obligations

Given its status as the world’s dominant currency, the USD naturally represents a majority of these reserves.


Currency Share of Total Reserves
US dollar 60%
Euro 21%
Japanese Yen 6%
Pound sterling 5%
Chinese renminbi 3%
Australian dollar 2%
Canadian dollar 2%
Other 3%

 

Japan and China are the world’s largest foreign holders of USD, with stockpiles of over one trillion each. These are often accumulated by purchasing U.S. Treasury bonds, a strategy for devaluing one’s domestic currency.

Because a large portion of China’s GDP is generated from exports, the country benefits when its currency, the renminbi (RMB), is weaker relative to the dollar. A relatively weak RMB means Chinese exports become cheaper than American-made goods.


Will The U.S. Dollar Continue to Reign?

Today’s shifting geopolitical and economic landscape presents challenges to the U.S. dollar’s global status.

China has overtaken the U.S. as the world’s major trading partner, and is looking to leverage its power to expand the presence of the RMB. Two factors that limit the RMB’s potential as an international currency are tight government controls and a lack of transparency.

Another threat to the USD’s dominance is the use of financial sanctions, which limit foreign access to the U.S. financial system. While these sanctions may be effective from a foreign policy perspective, they can also undermine the global role of the USD.

The following chart illustrates how Russia has circumvented the U.S. dollar in the face of American sanctions.

 

 

More specifically, Russia and China have been working towards a closer financial alliance. As of Q1 2020, just 45% of trade between the two nations was denominated in USD, down from 90% in late 2015.


Impact on Inflation

America’s M2 money supply has grown significantly since the 2008 global financial crisis, and even more so during the COVID-19 pandemic. M2 includes cash, checking deposits, and liquid vehicles such as money market securities.

Looking forward, U.S. inflation is expected to accelerate. In August 2020, the Federal Reserve announced it would switch to an inflation-averaging policy. This means that annual inflation will be allowed to exceed 2% in a given year, so long as the 2% target is achieved over a longer timeframe.

In some respects, higher inflation can be a positive. The U.S. debt to GDP ratio is currently over 100%, and by 2050, it’s expected to reach 195%. With so much debt being issued, sustained inflation can gradually undermine the real value of these liabilities. The tradeoff, of course, is a further weakening of the U.S. dollar.

 

Suggested Reading:


Some Color on Prices and the Markets Fixation on Inflation

A Look at Real Estate Risks to the Stock Market


How Much is a Trillion?

Money Supply is Like Caffeine for Stocks

 

Information and graphics are largely based on an article by The Visual Capitalist for New York Life Investments. Ancillary Sources are provided below:

https://advisor.visualcapitalist.com/how-dominant-is-the-us-dollar/

https://asia.nikkei.com/Politics/International-relations/China-and-Russia-ditch-dollar-in-move-toward-financial-alliance

https://fred.stlouisfed.org/series/M2SL

https://www.newyorklifeinvestments.com/?utm_source=VCweb&utm_medium=MM-ad&utm_campaign=Viscap-NYLhttps://www.statista.com/statistics/246420/major-foreign-holders-of-us-treasury-debt/

https://www.statista.com/statistics/246420/major-foreign-holders-of-us-treasury-debt/

https://crsreports.congress.gov/product/pdf/IF/IF11

 

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