The global percentage of assets and reserves backing the dollar, demanded by the world’s central banks, has fallen to its lowest level in 25 years, that is, to 59 % of the world’s total foreign exchange reserves.
As Wolf Ritchier, in his analysis in the financial blog Wolf Street, explains:, “Since 2014 the dollar has fallen 7% from 66% to 59%, falling on average one percentage point per year. At this rate, the dollar’s share would fall below 50% over the next decade.”
According to the study, central banks around the world have decreased their demand for assets that support the value of the dollar such as treasury bonds, mortgage-backed securities, corporate bonds, etc.
What could be causing the dollar’s decline as a global reserve currency and what does this mean for Americans are questions that would be asked by someone with little familiarity with the subject. The explanations, while they may be varied and complex, point to one path, the decline of U.S. hegemony as the dominant economy.
The dollar is losing hegemony against other currencies
For the economist of the firm Liceo Capital Advisors, Edgar Fernandez, the fall of the dollar as reserve currency is due to a process of convergence between the rest of the world and the US economy.
“In the long term, the growth of the U.S. cannot be that of the last three decades, because other developing economies have the advantage of arriving later, due to the fact that a developing economy has at its disposal the technology that another one has obtained much faster, and that effectively makes the world balance to be produced”, affirms Fernandez.
The loss of U.S. hegemony is due to the fact that other economies have been strengthening, so central banks have other currencies in which to diversify.
The dollar’s status as the dominant reserve currency is crucial for the United States to be able to continue to issue debt and finance its public spending, as well as to run trade deficits, allowing American citizens to continue to demand relatively cheap goods from cheaper countries, predominantly China and Mexico.
“The United States exports inflation, creates money, issues public debt, knowing that foreigners will buy those securities to have dollar reserves and in this way does not create inflation,” explains Fernandez.
This characteristic of the dollar is what allows the United States to incur high trade deficits and indebtedness without generating inflation, as explained by Luis Guillermo Vélez, PhD in Economics from the University of Nanterre: “When a country has a persistent deficit in the current account of the balance of payments, it eventually stops receiving financing and its currency devaluates, which allows it to increase its exports and reduce its imports and eliminate the deficit.”
For Dr. Velez, “a country whose currency is a reserve currency and a means of international payment can run higher trade and current account deficits for much longer without its currency devaluing”, which explains why the U.S. Federal Reserve can reach very high levels of issuance without inflation overflowing.
Despite the decline of the dollar as a reserve currency, the United States is still far from losing its hegemony in the foreign exchange market, as it is still widely accepted in the market and has a primary asset to keep it being chosen as a means of savings: confidence.
Although the dollar has lost preponderance as a reserve currency, it remains by far the currency of choice for holding central bank savings. The Euro still accounts for about 20% of the world’s foreign exchange reserves, yet its growth in the face of the dollar’s decline has been minimal.
Despite the magnitude of the Chinese economy, the renminbi is still not growing, occupying less than 3% of the world’s foreign exchange reserves. As Professor Fernandez explains: “As long as the United States has legal certainty and pro-free market laws, its currency will continue to have reserve value, no matter how much China becomes the world’s largest power, it will not have the confidence of the people by force”.
The yen gained strenght in front of the dollar
The currency that seems to be grabbing the attention of central banks has been the Yen. For this year the Japanese economy is expected to grow by 2.8% which is a telling fact considering what Japan has had for years. At the moment, the Yen’s reserves total about 6% of the central banks’ foreign currency reserves.
The pound sterling, meanwhile, maintains its position as the fourth dominant currency in the reserve markets and is on track to exceed 5% of the foreign currency reserves held by central banks.