Will the Dollar lose its reserve currency status?
3 min read
Hands counting us dollars with calculator and digital tablet
A reserve currency is a globally-recognized national currency commonly used in international trade and global finance. Although It’s hard to imagine that the greenback might lose its status as the reserve currency – it’s not impossible as some experts tend to argue. The Dutch guilder was the reserve currency for the most part of the 17th and 18th centuries till it was replaced by the Spanish dollar, then the pound sterling till about 1914 post which the dollar has been at the helm for the last 100 years or so. Modern Finance shows that the average lifespan of a reserve currency has been around 100 years. If we look back at history, it has been certain big events that have led the path for the change in the status of the reserve currency.
They can be broadly summarized into two parts;
- War and empire building
- Reckless and easy monetary policy
While these changes do not happen overnight – they broadly leave a few markers that if interpreted well in time can avert them from happening;
1 Ultra cheap money – There has been a structural deterioration in the fiscal situation of the US over the last few years has led to a concern that the US is debasing its currency. The Fed has added 3 trillion $ to its balance sheet in the pandemic that began In February.
Theoretically, there is only 1 way in which the dollar could collapse or lose its value;
- The most realistic risk is high inflation and high debt due to excessive money printing. The fiscal deficit would now stand at 3.8 trillion$ and the US public debt would exceed 100% of its GDP. Rising inflation in the future could force the FED to sharply raise interest rates. Could hamper its ability to its interest payments leading to a crash in the dollar,
2 The Trump Factor – One of the major reasons for a currency being a reserve currency is faith in its political institutions and administration.
The trade wars on China and its allies along with its assaults on the post-war global institutions it played the key role in creating and the incoherent and volatile nature of its policies towards the rest of the world and the sheer weirdness of the Trump years have undermined faith in its sophistication, competence, and integrity of the Trump administration and about the US being a superpower.
China holds about 1 trillion$ of investments – any intentional default from the US on its interest payment or China Unilaterally dumping its position would lead to further pressure on the dollar. Such events would also pave the way for others to lose confidence in the US and ultimately lead to the adoption of a different reserve currency. While as of today, there is no immediate threat that the dollar can lose its reserve currency status – if such an event would happen it usually is a multi-decade phenomenon.
Compared to the 1990s, – the dollar now forms 62% of the foreign currency reserves of various countries – down from over 90% in the ’90s. Do you think that other alternatives can take over from the dollar?
