May 24, 2023

Is the dollar’s dominance in doubt?

Throughout this year, the US dollar’s dominant position as the largest global reserve currency has been questioned. This is not the first time this questioning has arisen, having as precedents: the birth of the euro in 1999, the great financial crisis in 2008 and the cryptocurrency boom. That said, the perspective that China’s yuan could eventually function as a replacement is now beginning to gain strength.  However, we bring to the table some points that allow us to think that this scenario remains far off, as the US dollar has strong arguments to maintain its hegemony.

• On the one hand, nearly 60% of the reserves held by the world’s central banks are denominated in US dollars (vs. 67% 20 years ago). This is followed by the Euro with 20%, while the Yuan barely represents 3%. Another factor to take into account is that foreign investors maintain an important appetite for U.S. financial assets, either through government instruments such as Treasury Notes and Bonds or through stock shares.
• On the other hand, the U.S. dollar maintains an important role in the performance of the global economy, facilitating and speeding up a large number of transactions, due to the fact that around 90% of commercial operations use it as a currency of exchange. Meanwhile, trade in Yuan accounted for less than 2% of world trade in 2022.
• With regard to the Yuan, let us recall that it is not a freely convertible currency or one that operates under a free-floating regime, meaning that its value is determined by market forces, without the direct intervention of the monetary authorities.

In the short term, we do not rule out that the dollar will continue to lose momentum, mainly because the FED may pause the interest rate hike cycle that started last year. These ups and downs do not mean that the role we described above for the U.S. dollar is nearing its end. Let’s remember that a currency, in order to be considered a reserve currency, must be stable and secure, work as a means of exchange, store value, and be widely accepted and trusted. All of these characteristics are covered by the U.S. dollar, noting that the U.S. is the global financial center as well as the world’s largest economy with a stable political environment.