The recent fall in the USD has many commentators for the USD to lose its global reserve but it is highly unlikely. In this article we will look at why it will remain the global reserve currency as it has no serious rival.
If we look at Forex transactions from Bank for International Settlements (BIS) data it shows us the US dollar was on one side of 88 percent of all FX transactions last year which shows it’s still the which only underlines it’s the global reserve currency.
The United States accounts for just over 20% of global economic activity, but well over 50% of all international bank loans and debt securities are denominated in US dollars. If we look at overseas lending of banks in the UK and Euro zone for example – they lend more overseas in USD than they do in Euros or Pounds. In fact, for all the talk of the USD’s demise, its share in terms of international borrowing is at a level last seen 20 years ago again back in 2000.
In terms of Global reserves which are assets of central banks held in different currencies, to support their liabilities The U.S. dollar’s share reported to the International Monetary Fund was 61.3%way ahead of any other currency. The currency closest to the USD was the euro which accounted for 20.3% of global reserves which is down on its peak in 2009 when the euro’s share of global reserves was 28 percent.
US dollar markets are very liquid, and the US has the world’s largest bond market and in times of uncertainty money flows into them. Also, in terms of international bank loans in times of optimism and economic expansion loans are given in USD and converted to other currencies which means the USD is sold for a foreign currency. In times of economic contraction, loans are recalled by banks a USD buy and not so many USD loans are granted which means USD selling is reduced. Also, in times of stress the US is the largest economy and seen as a safe place to deposit money.
The fact that the USD is already the global reserve currency means it’s hard for another currency to take over – it’s the established reserve and there is confidence in it.
The Euro over the last decade has often been talked about as a global reserve currency but it won’t become one and as we noted above its share of global reserves has actually fallen. It won’t challenge the USD in the near future because the coronavirus exposed euro zone major problem, which is it’s just a financial union, not a political one.
We have seen member states argue over-budget spending and coronavirus bonds. In fact the political problems in euro zone may see it cease to exist in its current form. “The Euro may not be forever,” (Joachim Fels economic adviser at Pimco, the world’s biggest bond manager) He’s right and the Virus actually cemented the U.S. Fed’s role as global lender of last resort.
China is the world’s second super power and there are many commentators who see the Yuan as a possible rival to the USD since it was included in the IMF’s special drawing rights (SDRs) basket of major reserve currencies in 2016.
In terms of global reserves, it only accounts for just over which is projected to increase to between 5 and 10 percent by 2030 which leaves it trailing a long way behind the USD. It’s doubtful though that the Yuan will get to the levels forecast Why? Because China controls money flow in and out of China by using capital controls. This means the Yuan is not a freely traded currency so cannot be a global reserve:
“There is no obvious alternative to the dollar. The next two largest economies, the euro-zone and China, are both smaller than the US, and the euro (due to its still-fragile political underpinnings) and the renminbi (due to China’s capital controls and unique political system) have significant shortcomings as reserve currencies.” (Capital Economics’ senior economist Jonas Goltermann)
Despite trillions of dollars in foreign debt and continuous large deficit spending, the United States instils confidence in its ability to pay its debts. In March 2009 both China and Russia said that a reserve currency “that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies.”
Of course, both Russia and China politically and economically want to see the US weaker but politics aside it’s a good idea, but the reality is it won’t happen in the near future. People talk about the USD collapsing every few years but keep in mind if it did the whole global financial system would end in its current form with no rival to take its place.
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