A “de-dollarization” mania is gripping Washington and Wall Street.
Wall Street analysts, corporations, policy wonks and others are trying to ascertain whether there is any real threat to the U.S. dollar’s standing as the dominant global currency, along with how changes in the international monetary system might impact markets and the U.S. economy.
Interest in the topic, according to Mark Sobel, a longtime Treasury official and Chair of the Official Monetary and Financial Institutions Forum and others, is being driven by several developments, including the looming U.S. debt-ceiling battle in Congress, a China-brokered deal between Saudi Arabia and Iran as well as Beijing’s “no limits” partnership with Moscow, and growing unease abroad about Washington’s dominance over the global financial system.
“De-dollarization is one of the biggest things that our institutional clients are looking at,” said Jens Nordvig, a longtime currency-market strategist and founder of Exante data, which produces macroeconomic research for institutional clients, during a phone interview with MarketWatch.
Data show that the U.S. dollar’s share of foreign currency reserves at central banks around the world has been declining slowly since the late 1990s. According to the latest data from the International Monetary Fund, the dollar’s share of central bank reserves stands at 58.4%, down from roughly 70% in the late 1990s.
‘A stunning collapse’
However, one former Morgan Stanley economist believes this trend has been far more drastic than the IMF data suggest, in part because of the recent appreciation in the value of the dollar. Since January 2022, the ICE U.S. Dollar Index
DXY,
a closely watched gauge of the dollar’s value, has risen nearly 6%, according to FactSet data. It traded at 101.80 on Thursday, just above its lowest level in six weeks though.
“The [dollar] is losing its market share as a reserve currency at a much faster rate than is commonly believed,” said Stephen Jen, formerly of Morgan Stanley, and Joana Freire, in a research note sent to their Eurizon SLC Capital clients. In the note, Jen and Freire highlighted what they said were signs that the dollar’s decline had accelerated over the past year.
“The dollar suffered a stunning collapse in 2022 in its market share as a reserve currency, presumably due to its muscular use of sanctions,” Jen and Freire said, adding that these measures had “startled large reserve-holding countries.”
According to calculations from Jen and Freire, the dollar’s share of global reserves has declined by 11% since 2016 on this adjusted basis. Nordvig and others said that the IMF’s unadjusted data on central-bank reserves more accurately reflects the pace of the dollar’s decline as a share of reserve assets, seen as a critical barometer of a currency’s international standing.
Its role in trade is also seen as a critical barometer for a reserve currency. According to data from SWIFT, which facilitates transactions among banks internationally, the dollar is used in about 40% of global payments, making it the global leader.
Pros and cons of dollar dominance
Years after Valéry Giscard d’Estaing, former finance minister and former president of France first spoke of the dollar’s “exorbitant privilege” in the 1960s, some economists are evaluating the benefits and costs of having the dollar as a global reserve currency.
In a recent working paper for the U.S. Congressional Budget Office, economist Daniel Fried offered some examples, including heightened demand for assets denominated in the U.S. dollar, as well as lower interest rates, and a stronger currency that helps make imported goods less expensive.
“The dollar’s use as an international currency benefits American households and businesses primarily through two channels — by lowering interest rates for American borrowers, and by reducing the cost of imported goods and services,” Fried said in comments emailed to MarketWatch.
But if there is a trade off, it is that U.S. exports suffer, while the U.S. runs a gaping international trade deficit. In February, the most recent data available, the U.S. Bureau of Economic Analysis put the size of the U.S. deficit in trade in goods and services at $70.5 billion.
Foreign and domestic threats
Jen and Freire, and others, have caveated their analysis by saying they expect the U.S. dollar to retain its unilateral dominance for decades to come, if not longer, but they have also acknowledged growing foreign pressure to shift away from reliance on the dollar.
Efforts by Russia and China to denominate more trade in Chinese yuan have been launched, with China specifically pushing for more oil and natural gas to be traded in its currency.
But Sobel and others see plenty of domestic threats that could undermine the greenback’s legitimacy in the eyes of the international community.
Washington’s fiscal and monetary policies could undermine faith in the dollar over time.
Sobel and others have warned that aggressive use of financial sanctions against Russia and other countries could make some nations increasingly wary of the risks of using the dollar, but imprudent fiscal and monetary policy could also cause confidence to wane over time.
The current showdown over the U.S. debt ceiling is one example, Sobel said.
“If we run bad fiscal and monetary policies, if we close ourselves off, if we do idiotic things like default on debt and cause confidence to be lost in America, or if we excessively and unilaterally use financial sanctions, the dollar could see its role more quickly diminish,” he said during a recent appearance at the University of Wisconsin-Madison, video of which has been shared on the website of the school’s European Studies program.
Still, currency analysts caution that despite Moscow and Beijing’s best efforts, there is still no viable alternative to the U.S. dollar.
In his CBO report, Fried offered some examples of how policy missteps have contributed to the decline of reserve currencies past.
The dominance of the Dutch florin, or guilder, ended in the late 18th century, its decline driven in part by a loss of confidence in the Bank of Amsterdam after equity from the bank was used to help finance a war against Britain.
Another former global reserve currency, the British pound, started to see its influence challenged by the dollar in the 1920s, but according to Fried’s report the dollar emerged as the undisputed reserve currency in the 1950s, when a gold-backed dollar became the backbone of the global financial system under the Bretton Woods system after World War II.
Since then the U.S. dollar has seen undisputed global dominance. Whether a more diverse world political and economic order brings about a viable competitor to the dollar by then remains to be seen.
