Will the king be overthrown?

by Sean Tweedie | May 4, 2023

Dollar's Reserve Currency

Over the past few weeks, many major news channels have been talking about the end of the dollar’s reserve currency status. This is a trend that occurs when the value of the dollar falls, and it has been suggested numerous times over the past few decades. This time around the 11% decline in the DXY since its peak in September 2022 has sparked the recent ‘buzz’ around a ‘dollar collapse’. See figure 1


figure 1

risk of recession

Much of the concern around the dollar reserve status and the number of global transactions conducted in dollars as well as the power that it brings the U.S stems from the non-US allies. This concern spiked following Russia’s expulsion from the SWIFT payments system and the freezing of $300 billion of Russia’s foreign currency reserve by Western governments in response to the conflict in Ukraine. This so-called ‘dollar weaponization’ rattled countries willing to trade with Russia, and so has indeed seen more trade between the nations in currencies other than the dollar.

It is true that the dollar’s share of global reserves has declined over the past decade. However, when comparing today to the 1990s, we see that the dollar’s share has in fact increased. See figure 2


figure 2

risk of recession

At this stage, there is not much evidence that the market’s demand for dollar reserves has declined much. One thing that strengthens the case for the dollar is the ‘network effects’ that it offers. This stems from the dollar being far more accepted and traded than currencies of smaller economies. If for example you held an ‘exotic’ currency like an Icelandic Króna and wished to exchange it for South Africa rands, the process would be a lot easier to purchase dollars with the Króna and then to purchase rands with the dollar.

If we look at the dollar’s share of global transactions, however, by far the largest share is conducted in dollars (presently around 88%). Furthermore, the dollar’s share of global transactions has in fact increased over the past decade, which comes at a time when central banks have been diversifying into other currencies. See figure 3


figure 3

risk of recession
Correspondingly the euro which accounts for the second-largest share of global transactions has decreased from 39% in 2010 to 31% in 2022.

Although central banks have been reallocating away from the dollar, the pace of the reallocation has been very slow and it has been into currencies of smaller open economies like JPY, GBP, and even the CAD. Although China has a geopolitical incentive to diversify away from the dollar and increase the appeal of the RMB, its share of global reserves is only around 2.7%. Furthermore, China has capital controls in place and so lacks the free market appeal of some of the other economies.

So to conclude on this point, we do not believe that over the next 6 to 12 months we will see a destabilisation of the dollar and a major de-dollarisation trend.

So where to now for the dollar?

The US dollar is a countercyclical currency, meaning that it tends to weaken when global growth is higher outside the US than growth within the US. If we look at the growth estimates of major economies, baring barring Japan and Australia, all have risen. See figure 4

figure 4

Lower natural gas prices have given the European economy a boost. The Chinese economy is recovering. Retail sales have rebounded, as have home prices and home sales. Import demand is also rising, which bodes well for exporters into China.

If these growth estimates do materialise then we could well see that the dollar facing pressure over the coming months.


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