The US dollar is going to be the world’s dominant reserve currency for a very long time to come, says James Lord, a top FX strategist at Morgan Stanley. He pointed out that China’s strict zero-COVID policy was hurting the Yuan.
However, the global dominance of the dollar shook when the US and its allies froze much of Russia’s foreign-exchange reserves. Analysts highlighted that a number of countries decided to diversify their reserve holdings away from the dominant currency, in an effort to reduce US’s power over the global economy.
Power of the US dollar
The dollar rose as a dominant currency when the Bretton Woods accord was reached in 1944. Former US President Donald Trump had reinforced the dollar’s place at the heart of international systems. According to International Monetary Fund data, global reserve managers in 2019 cut their US currency holdings as a percentage of their total stockpiles close to the lowest level since the 1990s. Experts say they may have accelerated the rush into dollars that came about as the COVID-19 pandemic spread in March. The pandemic and the rush into the US dollars made other currencies like the Australian dollar, Mexican peso, and Korean won, volatile.
Barry Eichengreen, a professor of economics and political science at the University of California in Berkeley, highlighted that things haven’t changed but have in fact been reinforced in the early stages of the global health crisis. He said the pandemic and dollar-related facts raised renewed concerns about the mismatch between the dollar-centric international financial system and the multipolar world. Eichengreen described it as an “uncomfortable situation”.
Toppling the dollar’s reign
If governments indeed want their respective currencies to rise, toppling the dollar is just a blink away. Lessons can be drawn from the centuries gone by. Experts say that in the 17th and 18th centuries, the Dutch guilder filled the role before the Spanish dollar came in. There was the Pound sterling from 1860 to around 1914. The country’s dominance of global trade and finance held key to the currency’s status, backed by central banks and regulatory maneuvers.
Geopolitical uncertainty can create disturbances. During World War 1, the British government resorted to capital and exchange controls. It came up with an alternative sterling when the Federal Reserve Act created a US central bank to provide liquidity to dollar markets. In present times, Russia’s assault on Ukraine has encouraged central banks to contemplate shifting away from the dollar. But it isn’t going to be a cakewalk as an alternative currency doesn’t exist.
Experts note that countries cannot shift to the Euro or Yen because Europe and Japan stand with the US in applying sanctions. It’s not impossible for countries like China and Russia to topple the dominance of the US dollar. But there are a lot of challenges and catches. Among these catches are that restricting or limiting the international use of the dollar would be opposed by many in Wall Street, foreign affairs, and military establishments.
The strongest world currency
Lord says the dollar is “the cleanest dirty shirt” as the world deals with slowing growth and high inflation. This is somewhat also backed by the freezing of Russian assets. The strategist believes that the US dollar is going to be for most reserve managers, maybe not all, the safest asset. Sanctions have not pushed away countries from the US dollar.
In regards to the yuan as an alternative, Lord said the Chinese currency does not appeal to investors. He attributed this to China’s strict approach to containing the COVID-19 pandemic, which pulled down the yuan. It is down 7% against the US dollar, so far, this year.