Charbel Cordahi, Grenoble School of Management (GEM)
The international monetary system, dominated by the dollar, is the subject of growing concerns. On the one hand, new powers are seeking to free themselves from the greenback; on the other hand, the preponderance of the dollar in invoicing global trade and issuing debt far exceeds the share of the United States in the international economy and trade.
The factors explaining the predominance of the dollar are well known: the United States is a large economy open to trade and capital. They have vast financial markets, are a military and political superpower, and their universities produce excellent graduates and research work, among other things.
Since the dollar replaced the pound sterling as the international reserve currency after World War I, it has continued to consolidate its status. This dominance stems not only from the international role of the United States, but also from the absence of sufficient alternatives in investment-grade government securities, which investors can hold as safe assets and which central banks can hold as reserves exchange.
Even when crises originate in the United States, the importance of the dollar does not diminish. On the contrary, it attracts foreign capital in search of security and responds, through currency swap agreements, to the needs of the central banks of the partner countries of the United States, which thus manage to provide dollars to their banking systems.
Considerable challenges
Internationally, rivalry with the dollar has intensified since the 2000s due to several factors. First of all, due to the strengthening of the institutional structure of the euro and the desire of the European monetary authorities to support the single currency by all means.
Then, by the growing role of the Chinese renminbi, which is becoming increasingly used for invoicing global trade. This development is encouraged by the creation of renminbi swap mechanisms and by the increase in the weight of the Chinese currency in the IMF’s basket of special drawing rights (SDRs).
A third element is the rise of digital currencies, which could encourage economic agents to reduce their use of the dollar for their reserves, as well as the appearance of new payment systems, facilitating exchanges thanks to their low transaction costs.
The price of power?
In turn, swap agreements between central banks are increasing, reducing dependence on the US dollar in financial exchanges. Added to this is the search for higher returns by central banks, which are allocating an increasing share of their investments to currencies offering more attractive returns than those denominated in dollars.
Another factor is economic sanctions imposed by the United States on certain countries, which pushes other nations to diversify their reserves away from the dollar, for fear of being targeted by similar measures in the future. Some have even proposed the creation of a currency for “global South countries” as an alternative to the dollar (even if this idea has little chance of success due to the heterogeneity of the economic, social and political contexts of these countries).
A sixth factor stems from internal instability in the United States and recurring debates over the public debt ceiling, which could undermine the confidence of foreign investors and governments, prompting them to reduce their dollar assets. Finally, the increase in commodity transactions denominated in currencies other than the dollar could in turn intensify competition with the American currency.
The current landscape
The share of dollar foreign exchange reserves held by central banks continues to decline. At the end of the 1990s, the dollar accounted for 71% of foreign exchange reserves held by central banks. According to the IMF, in the second quarter of 2024, this proportion fell to 58.2%, followed by the euro (19.8%). However, this drop in the dollar’s share of foreign exchange reserves was only partially to the benefit of the renminbi, with only a quarter of this shift going towards the Chinese currency.
Much of the dollar reserves are invested in U.S. government bonds, with foreign investors holding about a third of outstanding Treasury securities, up from nearly half a decade ago. This figure must nevertheless be interpreted with caution: in value, the decline comes almost exclusively from the reduction in outstanding amounts held by China, which have fallen by $548 billion in 10 years. This decrease was offset by an increase in investments from other countries, notably the United Kingdom, which increased its investments by 573 billion during the same period.
Who holds the 100 dollar bills?
Another way to measure the importance of the dollar is to look at the holdings of bank notes. Foreign agents hold approximately 50% of the value of notes (paper money) issued by the Federal Reserve, with 60% of notes in circulation and 80% of $100 denominations stored outside the United States.
The influence of the dollar is also visible through its role in invoicing international trade. According to the Federal Reserve, over the period 1999-2019, the dollar was the billing currency for 96% of bills in the Americas, 74% of bills in the Asia-Pacific region, and 79% of bills in the rest of the world. world. The only exception is Europe, where the euro dominates in 66% of cases.
While the United States accounts for only 9% of global trade, the dollar remains the most frequently used currency for cross-border payments via the Swift network, with a share above 45%.
The king of exchanges
At the level of international banks, around 60% of loans and deposits abroad are denominated in dollars. In addition, 70% of bonds issued in foreign currencies are in dollars. This proportion has remained stable over the last decade.
The dollar also enjoys a high share in foreign exchange transactions. According to the Bank for International Settlements (BIS), the dollar is involved in around 88% of currency trading across the world as of April 2022. This share has remained stable over the past 20 years.
Although the role of the dollar is in relative decline and the international monetary system is moving towards multipolarity, it is very likely that the dollar will maintain, at least until 2045, its dominant position. In the meantime, other currencies will become increasingly important, but none will replace the dollar, which will continue to play a major role in trade and pricing, as well as as a safe haven asset.
In the long term, things could change. The shift towards a more multipolar world on a geopolitical level, the rise of China, the continuation of economic integration within the euro zone, the strengthening of financial markets in the countries of the BRICS group, the increase in he United States’ debt, as well as the rise of digital currencies, are all factors that could reduce the influence of the dollar and weaken its current status.
Charbel Cordahi, Professor of Finance & Economics, Grenoble School of Management (GEM)
This article is republished from The Conversation under a Creative Commons license. Read the original article.
