Is The US Dollar At Risk Of Losing Reserve Currency Status?

Dollar weakness is a topical subject this year, inspiring new forecasts that the currency is in danger of losing its reserve currency status. Advocates of this outlook point to various clues that suggest the end is near. But a careful review of the likely replacements suggest that the greenback will retain is central role in world trade for years to come.

That’s not to say that near-term factors won’t weigh on the buck or that the US dollar’s position as the world’s reserve currency is permanent. Given a long enough time frame, it’s plausible, perhaps even inevitable, that the dollar-centric global economy that’s prevailed post-World War II will give way to something else. But getting from here to there will take time, probably decades. Meanwhile, the dollar’s position as the reserve currency remains secure, albeit battered and bruised relative to post-war history.

Recent estimates find that roughly 60% of central bank reserves are held in dollars. That’s down from previous decades and will likely slip further in the years ahead. But a rapid decline in the short run is unlikely, in part because the alternatives to the buck aren’t particularly attractive for a variety of reasons.

Source: crsreports.congress.gov

I briefly discussed the subject in a podcast earlier this week at The Milwaukee Company and it’s worth developing some of my talking points in more detail. Let’s focus on the would-be replacements to the US dollar as a reserve currency.

China: The economic rise of the country over the past 40 years suggests that the US dollar will hand off the baton to the yuan, echoing the shift from the British pound to the greenback during the first half of the 20th century. But unlike the former changing of the guard, China’s currency isn’t ready for prime time as a reserve currency.

There are several reasons why the yuan isn’t set to displace the dollar as the world’s primary reserve currency. Perhaps the leading factor: China has yet to allow free trade of its currency and substantially reduce or eliminate the peg to the greenback. China also restricts capital flows in and out of the country, which is a non-starter for a reserve currency in the eyes of most institutional investors. Other impediments to the yuan’s rise as a true reserve currency include a lack of transparency in China’s financial markets on par with the US. A distinct lack of clarity and transparency for China’s monetary policies is another challenge.

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Disclosures: None.

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