Status of US Dollar as Global Reserve Currency and Exchange Rates: Slow Long-Term Decline on Track
by Wolf Richter • Apr 2, 2023 • 162 Comments
But the Chinese Renminbi didn’t make any progress at all last year.
By Wolf Richter for WOLF STREET.
The share of the US-dollar as global reserve currency dropped to 58.4% at the end of Q4, according to the IMF’s new COFER data. This was the dollar’s lowest share of global reserve currencies since 1994.
Back in 1978, the dollar’s share started plunging from around 85% of global exchange reserves as inflation exploded in the US, and other central banks got cold feet holding securities denominated in this stuff. In the 1980s, inflation started to come down. But central banks – and the rest of the world – took a long time to regain confidence in the dollar, and the dollar’s share of reserve currencies didn’t bottom out until 1991, with a share of 46%. Then came the bounce until the euro showed up, which put a stop to the bounce. The chart shows the share of the dollar at the end of each year.
The US dollar as global reserve currency means that foreign central banks and other foreign official institutions hold US-dollar-denominated assets, such as US Treasury securities, US corporate bonds, US mortgage-backed securities, and the like.
These institutions also hold foreign exchange reserves other than dollar-assets.
The other major reserve currencies.
The euro is the second largest reserve currency, with a share of 20.5% at the end of 2022. Back in the day when the euro was created, there was talk that it would reach “parity” with the dollar, but the Euro Debt Crisis brought to light the euro’s structural weakness, which ended the parity talk, and the euro has maintained a share of roughly 20% since then.
The yen, the third-largest reserve currency, had a share of 5.5% (purple line at the top of the colorful spaghetti at the bottom in the chart).
The British pound, the fourth largest reserve currency, had a share of 4.9% (blue line just under the yen).
The Chinese renminbi, the fifth largest reserve currency, lost a little ground last year, with its share dipping to 2.7% at the end of 2022. Due the capital controls, convertibility issues, and other issues, it seems central banks are leery of RMB-denominated assets and are moving slowly or not at all. At this pace, the RMB won’t get close to the USD as reserve currency for decades (green line near the very bottom).
China: It is also likely – and I think good for the global and even the US economy – that China’s RMB-denominated assets, given the huge size of the economy, will eventually ever so slowly become a larger player amid global exchange reserves.
The Yuan will not replace the US Dollar as the Reserve Currency of the World.
4 Reasons Why Yuan Won’t Replace Dollar as Reserve Currency
The battle is on between the dollar and yuan as the world’s reserve currency. Or is there a battle at all?
The dollar will remain the world’s top reserve currency—not the yuan any time at all—and for four good reasons to be spelled out in a while.
A CNBC report early this year echoed a general sentiment that the greenback is ready for a fall as the top reserve currency by 2015. Meaning, countries will stop using our money to exchange goods, or conversely, we need to change our dollar to another currency to export or import goods.
To be clear, and to the credit of the CNBC report, the dollar is still the major reserve currency. It holds 62% of the world’s aggregated reserve currency. In short, most of the central banks in other countries hold a lot of dollars for the capital market.
The yuan is not even among the next top four reserve currencies: the euro, yen, pound sterling, and Swiss franc.
How many people truly understand the dynamics behind the yuan? Maybe as many as the 35 members of China’s State Council.
The lack of transparency will be the main drawback against the yuan. Stability is the biggest factor why countries gravitate to the dollar, which has not been devalued ever.
The yuan, on the other hand, is tightly controlled by China, even as Western countries led by the US call for more liberalization of the yuan.
The UN Population Division and Goldman Sachs predicted in 2011 that Chinese middle class will be four times larger than the American middle class population by 2030. Sure, but it is not because Americans are getting poorer; the Chinese are just getting richer. And middle class people seem to think along the same line. They want assurance from their leaders.
The uncertainty of this situation will likely pressure many rich middle class Chinese to invest in a more transparent environment like the US, not unlike the substantial migration of investments that happened from Hong Kong to Canada before the colony was handed to the mainland in 1997.
Money-wise, the rising middle class in China will spill over to the US economy. More Chinese are likely to spend in the world’s number one biggest economy (makes sense) and more US companies will sell more in world’s second biggest economy, China.
These political, demographics and economic factors only add, not subtract, to the strength of the US economy.
The yuan is already being traded directly between China and two other countries: Australia and Japan. That means, both countries do not need US dollars to trade with China.
Does it mean the yuan is gradually encroaching into the dollar reserves of other countries? Yes and no. The encroaching only goes as far as the bilateral trade between China and that other country.
Manufacturing is China’s main strength, but world trade also involves a big chunk of financial, science, intellectual property, and information technology trade among others. For the yuan to replace the dollar in world trade, China has to go past making cheap products, it seems.
Yes, China is embarking in infrastructure development, exporting its construction and engineering to mostly developing countries. But that’s a long road to take and one that will face stiff competition from the US apart from the other reasons we mentioned above.
History is on dollar’s side
The world’s reserve currency had always gravitated to the country or empire that dominated its neighbors. The ancient Greece’ silver drachma, the Roman-issued coins, the Byzantine’s gold solidus, and the Arabian dinar were some of the dominant currencies during their respective ancient reigns.
As for the dollar, the landscape cannot be farther from the historical trend. The US dollar is built on the strength of a single, solid market of Americans who buy and sell stuff. That’s a huge starting point; add to that the collective historical, cultural, and political ties of the Western countries to the US.
Perhaps it is a historical first that a universal currency is being used by the largest pool of consumers who belong to a country, and more importantly, who will defend this country from outside threats.
The US dollar sits on a solid bedrock of its over 310 M population, while the yuan is spread across 1.3 B Chinese who will start demanding more rights from their government as they get richer.
Make no mistake the yuan is destined to be a major world reserve currency, if it is not yet. The farthest it can do to the dollar is eat up a chunk of the world’s dollar reserves through bilateral negotiations. Other than that, the yuan, at best, will elbow out the other major currencies as a world reserve currency, but not the dollar.