The US Dollar has held a pre-eminent place in the world’s economy since the end of World War II. Its wide acceptance has meant it comprised the lion’s share of global reserves and settlement of trade and served as a global benchmark for many countries to peg their currencies. According to the Bank for International Settlements, the US Dollar remains the single-most traded currency in the FX market, with nearly 90% of FX transactions involving the greenback in some way.
There have always been questions about how long the US Dollar would be able to retain this special status. There have been many attempts to find replacements over the past 75 years, especially as the non-US share of the world economy has grown. Is the world really ready for ‘de-Dollarisation’?
To answer this question, we would need to get more specific about what ‘de-dollarisation’ really means. The US Dollar arguably holds two key roles in the global financial system in this context. The first is its role as a reserve currency for global central banks. The second is its role in settlement of global trade flows.
Dollar still a key reserve currency
Several arguments have been made about what central bankers look for when considering allocating to non-US Dollar currencies: (i) the presence of open capital account, (ii) greater ease and lower cost of trading non-USD currencies, (iii) track record of economic and policy stability, (iv) the presence of US Dollar swap lines, which should raise confidence in the currencies, (v) opportunity to diversify away from the US Dollar into currencies that offer higher returns and lower volatility and (vi) geopolitical objectives.
When placed against this context, it is easier to explain some of the changes we’ve witnessed in global reserves in recent decades. The US Dollar remains the largest global reserve currencies; it comprises just under 60% of global foreign exchange reserves. The Euro has arguably had the most success as an alternative reserve currency and now comprises just over 20% of global reserves. More recently, an IMF study noted that much of the shift away from the US Dollar in recent years was driven by formerly less popular currencies such as the Australian Dollar, Canadian Dollar, Swedish Krona and South Korean Won. The share of the Chinese Renminbi also rose.
As the IMF put it, the US Dollar’s share of global foreign exchange reserves continues to extend what has been a two-decade decline, but it is still used more than all other currencies combined.
Other currencies make progress in trade settlement
When it comes to settlement of global trade, non-US Dollar currencies form a rising share. The Bank for International Settlements noted that the US Dollar’s share in trade invoicing and payments ranges from about 40-50%, smaller than its share in global reserves but much larger than its share of global trade. Having said that, regional variations around this broad average can be large. SWIFT data shows the bulk of global trade (over 75%) was cleared in US Dollars and Euros, despite other countries forming a significant share of global trade.
Factors cited for a currency’s use as a trade settlement currency are similar to those for a reserve currency. The one additional factor important in a trade settlement context is how the currency used can be ‘recycled’ i.e., if a country’s exports are settled in a certain currency, can that currency be subsequently used to either purchase imports, or be deployed in global investments?
Investor implications – gold could be a surprise winner
In recent months, we have seen an escalation in efforts to create alternatives to the US Dollar. Much of these efforts are focused on trade settlement. For instance, at a multi-lateral level, there have been calls for the creation of a BRICS currency. Countries are also making increased efforts to develop mechanisms for settling bilateral trade in local currencies.
For investors, though, we believe any such shift will be gradual. As data on the US Dollar’s share in both global reserves and trade settlement shows, any changes tend to be slow, running through decades. This arguably makes sense given the factors that drive the development of reserve currencies.
Gold, of course, could be a somewhat unexpected beneficiary of the US Dollar’s long-term decline. The precious metal offers central bankers one immediate source of diversification out of the US Dollar. This is an option global central banks already appear to be exercising, given the sharp rise in central bank gold purchases since early 2022. While we do not see gold as a significant alternative to the US Dollar – there simply isn’t enough gold available for it to become the dominant reserve asset – central bank purchases are likely to impose a floor on prices, especially if other factors like falling real bond yields and safe haven demand offer support.