Yahoo Finance The world is ‘jockeying for what comes next’ as fewer U.S dollars are held in foreign reserves — here's why that could weaken the U.S.
Since 1944 the U.S. dollar has been the dominant currency, with many countries choosing to hold it in reserve. But the situation is changing. More countries are looking at alternative currencies to hold onto, casting doubt on the U.S. dollar's power.
Don’t miss
Mitt Romney says a billionaire tax will trigger demand for these two physical assets — get in now before the super-rich swarm
You could be the landlord of Walmart, Whole Foods and Kroger (and collect fat grocery store-anchored income on a quarterly basis)
What do Ashton Kutcher and a Nobel Prize-winning economist have in common? An investing app that turns spare change into a diversified portfolio
For instance, Israel added the Chinese RMB to Central Bank reserves for the – first time – in April. In its new strategy, it also increased the portfolio’s holdings of the Australian dollar, Canadian dollar and Japanese yen.
“America gets a significant economic advantage from the status of the dollar. When other countries increase their dollar holdings, the final product of the string of transactions involved is that the U.S. gets real goods and services in exchange for the paper the fed ‘prints,’” said David Laidler, economist and professor emeritus at Western University, in London, Ontario, Canada.
Many countries who are close trading partners with the United States are highly dependant on the dollar's value and it's position as a reserve currency. However, a more diminished U.S. foreign reserves and increased, in say, Canadian ones, means Canadians will “enjoy certain benefits,” says Worku Aberra, a professor of economics at the Montreal-based Dawson College.
“It is a zero-sum game; a loss to the U.S. is a gain to the other countries whose currencies are being accepted as reserve currencies,” added Aberra.
Rise of non-traditional currencies
The U.S. dollar rose to become a dominant currency starting in 1944, at the Bretton Woods Conference. Attended by 44 countries, it allowed other countries to accumulate reserves of U.S. dollars.
Countries use foreign currency reserves for numerous reasons. They benefit from having liquid currency in case of crisis, it helps price their exports competitively, but they also require reserves to pay external debts or simply make profits out of diversified portfolios.
While the U.S. dollar is still dominant more than 70 years later, there have been some notable developments that could possibly threaten its hold.
One of these developments is the emergence of currencies considered previously non-traditional that have earned the honorary title COFER, which stands for Currency Composition of Official Foreign Exchange Reserves.
International Monetary Fund data for the first quarter of 2022 shows an increase currencies like the British pound, the Australian dollar, the Canadian dollar and Swiss franc held by world countries as foreign reserves.
While it’s “admittedly a small fraction of the total world reserves,” said Aberra, it’s, however, a “significant increase in the normally tectonic changes of international reserve holdings.”
Rising competitors
Changes in the makeup of foreign reserves are disrupting the status-quo list of what has long been known as the big four: the U.S. dollar, the British pound, the Japanese yen and the euro. The big four dominated foreign reserves, accounting for 98% of the foreign reserve in 1999, and standing at 92% as of 2021.
In the first quarter of 2022, the IMF shows that there are $287 billion Canadian dollars held by world countries as foreign reserves. Australia is also making strides, with countries holding about $225.48 billion Australian dollars in the same period. Some countries are joining forces politically to seek out reserve currency options besides the U.S. dollar.
In late June, President Vladmir Putin signaled that Russia, and other members of BRICS (Brazil, Russia, India, China, South Africa) are going to create a new international reserve currency.
Not only that but more countries are showing interest in joining BRICS, including Saudi Arabia and NATO-member Turkey.
The decline also means an “increase” in the cost of financing the U.S. balance of payments and budget deficit.
“If people holding Eurodollars start using their dollars to buy U.S. goods and services, there will be a transfer of real resources from the U.S. to the rest of the world,” the professor said.
Rise of digital currency and weaponization of U.S. dollar
Some also warn that the increase in digital currencies could also threaten the U.S. dollar's place on a world stage.
During a CNBC interview in March, Jeremy Siegel, a professor at the Wharton School of the University of Pennsylvania warned of “bitcoin taking over” as inflation began its escalation.
Siegel’s fear isn’t unfounded.
“I think this trend will be accelerated as a result of technological changes in international payments, the proliferation of regional trading blocs that will create their own systems of international payments, and the increased weaponization of the U.S. dollar as a foreign policy instrument by the U.S. government against a number of emerging and developing countries,” Aberra explained.
Putin’s defiance for example probably comes as no surprise. After all, Moscow admitted in March that it can't use nearly half of its $640 billion in foreign currency following Western sanctions.
Still hope for U.S. dollar
In spite of challenges facing the U.S. dollar, not all studies are gloomy.
A study by the Federal Reserve Bank of New York staff had a more optimistic outlook on the dollar’s strength.
“The dollar’s international role, whether for trade, investment or use as a global reserve currency, remains quite strong, with nothing on the horizon likely to rival it,” authors Linda Goldberg, Robert Lerman, and Dan Reichgott wrote on July 5.
In their study, the authors confronted all the points pitched against the U.S. dollar.
In hindsight of the growth of the digital currencies such as central bank digital currencies (CBDCs) and cryptocurrencies, there is the “preponderance of efforts to anchor stablecoins against the U.S. dollar.”
“Virtually all stablecoins (on a value weighted basis) aim to maintain a ‘peg’ with the dollar,” they said in defence of the currency.
The authors also explained that the U.S. dollar remains by “far the most traded currency” worldwide.
“Approximately half of all cross-border loans, international debt securities, and trade invoices are denominated in U.S. dollars, while roughly 40% of SWIFT messages and 60% of global foreign exchange reserves are in (U.S.) dollars,” their defence continued.
What does this mean for the future?
As the debate lingers, skeptics such as Frank Giustra, a Canadian businessman and co-chair of the International Crisis Group admits that the U.S. dollar “still rules” but acknowledges the wind of change that the “world is clearly jockeying for what comes next.”
While non-traditional currencies from Canada and Australia, both Liberal democracies as well as major commodity exporting nations make them more attractive, the end result isn’t clear.
But then, no one is holding the crystal ball predicting how the new world order is going to unfold. Who knows, we might eventually have a leaderless digital currency taking over, making U.K., U.S. or Australian foreign reserves less important.
What to read next
Sign up for our MoneyWise investing newsletter to receive a steady flow of actionable ideas from Wall Street's top firms.
Warren Buffett likes these 2 investment opportunities outside of the stock market
'Imagine you are laid off’: Suze Orman's tough-love tips to prepare for the recession ahead
This article provides information only and should not be construed as advice. It is provided without warranty of any kind.
