Is de-dollarisation a real possibility?

There are plenty of reasons to doubt the durability of the USA as a hegemonic power these days - and thus the durability of the US dollar as the world's leading reserve currency. But sceptics have called time on dollar dominance before - and been proven wrong.

Wendy Cooper, guest author
4 minutes
Close-up of some USD banknotes
The dollar tends to remain strong amid challenges, but this does not make it immune to the consequences of political changes, says Sebastian Petric of LGT Private Banking. © istock/Gordan1

Wars are raging. A highly contentious US presidential election is looming. Adversaries are circling. Allies are growing nervous. All of which is leading many to wonder if the dollar's reign as the primary reserve currency is finally over. Well - not quite yet, according to the experts.

A man in a suit and tie smiles neutrally while looking into the camera
Sebastian Petric, Senior Investment Strategist/Fixed Income and FX at LGT

"Geopolitical tensions can influence economic perceptions, potentially eroding some aspects of this dominance over time," observes Sebastian Petric, head of FX Strategy at LGT. Even so, he explains, "While there's some perception of waning Western economic dominance, this does not fully translate into reality". The depth and sophistication of US financial markets, along with the dollar's role in global trade, continue to underpin its strength.

The greenback, in short, looks set to retain its dominant position, at least for now. So how did it get there? And what has sustained its more than 70-years at the pinnacle of the global financial system?

Reaping the rewards of "exorbitant privilege"

A man in a suit and tie is speaking in a historic government building. The image quality makes it clear that the image is dated.
Former French President Valery Giscard d'Estaing once described the reserve status of the US dollar as an "exorbitant privilege". © Keystone/Rue des Archives/Str

The dollar's role as the primary global reserve currency mirrored the emergence of the US as the world's biggest and strongest economy after World War II. The 1944 Bretton Woods agreement created a collective international currency exchange regime that pegged the dollar to gold, and most other currencies to the dollar.

Reserve status reflects global demand for a currency, and the US economy, thanks to its sheer size, free capital flows, and robust banking system, has clearly earned the international confidence required to retain such status. Meanwhile, Washington has reaped considerable rewards from what former French President Valery Giscard d'Estaing once called its "exorbitant privilege".

The dollar is not immune to political changes.

Sebastian Petric, LGT Senior FX Strategist

The US government, for example, can (and does) leverage the dollar's status to impose economic sanctions on regimes and individuals it deems undesirable, thus boosting its geopolitical clout.

High global demand for dollars also allows both the US government and US businesses to borrow at lower cost. And while that privilege risks the accumulation of significant debt, the value of the debt does not change with fluctuating exchange rates, and is thus relatively easier to service. As Petric remarks, "Seigniorage [the profit made by a government by issuing currency] may be the most important advantage of dollar supremacy."

De-dollarisation is a perception, not a reality

Cargo ship manoeuvring into container port, bird's eye view
More than 60 per cent of global trade transactions are still denominated in dollars: de-dollarisation is more a perception than a tangible reality. © unsplash

According to Petric, "De-dollarisation is primarily a perception rather than a tangible reality." Yet predictions of de-dollarisation - the demise of the dollar as the primary reserve currency - have proliferated since the 1970s, when the oil crisis severed the greenback's link to gold. In 2020, for example, after hitting a three-year high, the Dollar Index (a measure of the US currency's strength against a basket of six other currencies) had one of its most dramatic slides ever.

A key reason, however, was the massive US Covid-19 relief program, and the Fed's expansionary monetary policy, which proved temporary. Despite the collapse of the Bretton Woods system, fluctuations in the dollar's exchange rate and the rise of other global economic powers, IMF data on the composition of foreign currency reserves indicates that the dollar's share of global reserves today is roughly the same - and it has never fallen below 50 per cent. Furthermore, more than 60 per cent of global trade transactions are still denominated in dollars. 

Plenty of competition but no viable alternative

Five men stand in front of a poster reading "BRICS Summit".
Even relatively large emerging economies, such as some of the BRICS+, typically don't have well-developed and open financial markets (the heads of state of Brazil, China, South Africa and India and the foreign minister of Russia are pictured). © Keystone/pool/Alet Pretorius

No other currency offers a real alternative, although there's plenty of potential competition. Take the euro, for example, which appears to fulfil many of the requirements needed to qualify as a global reserve currency. It's the common currency of an economic area only slightly smaller than the US economy, and with a relatively sound macroeconomic policy record. The euro is also freely convertible, and together with the dollar, is the currency to which other currencies are pegged.

Yet although total sovereign debt outstanding in the euro area rivals that of the US, and many observers expect the common currency to become more important in central bank allocations over time, monetary union remains incomplete.

Similar factors help explain why no emerging market currency holds a visible share of global foreign currency reserves. A few emerging markets have become international trading powers, and several have established a history of sound macroeconomic policies resulting in low inflation and sustainable public debt levels. However, even relatively large emerging economies, like some of the BRICS+, typically don't have well-developed and open financial markets. 

A question of confidence - and structural advantage

Over time, of course, financial markets in many emerging economies are almost certain to become more developed and integrated with global capital markets, suggesting a greater international role for their currencies and greater diversification of the world's foreign currency reserves. 

A man smiles in a friendly manner into the camera
Cornell University Professor Eswar Prasad's work shows that the dollar's strengths continue to outweigh its weaknesses.

What's more, the current global geopolitical climate presents undeniable challenges to US hegemony. "International confidence is a cornerstone of currency stability," notes Petric. "The persistence of the dollar's strength amidst these challenges speaks to its ingrained role in the global economic and financial system, but does not render it immune to the consequences of political shifts."

Even so, Petric cites the work of both the Berkeley economist Barry Eichengreen and Cornell University's Eswar Prasad to support his conviction that the dollar's strengths continue to outweigh its weaknesses.

Eichengreen's research suggests that while systemic changes in the global economic landscape could challenge dollar dominance over time, the US' huge structural advantages, which include a long-established financial infrastructure and confidence in US economic management, provide resilience against rapid geopolitical changes. Prasad, meanwhile, emphasises the rule of law, efficient financial markets, and the innovative nature of the US economy as critical pillars of US economic strength.

"De-dollarisation is not a new question," concludes Petric, "but the US always prevails."

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