The Financial Times recently published an article titled “Dollar :-(” discussing the changing status of the US dollar as a reserve currency. While we typically approach sensational headlines with caution, Stephen Jen, a renowned currency analyst known for coining the “dollar smile” theory during his tenure at Morgan Stanley, has raised some noteworthy points.
In his recent briefing note, Jen argues that the US dollar has experienced a notable decline in its role as a reserve currency, and this trend seems to have accelerated following Washington’s use of its influence over the dollar-based global financial system in relation to Russia.
Jen’s analysis suggests that, when adjusted for price changes, the US dollar’s share of official global reserve currencies has decreased from approximately 73 percent in 2001 to around 55 percent in 2021. Furthermore, it dropped to 47 percent in the previous year.
Of particular significance is the observation that the decline in the US dollar’s market share as a reserve currency in 2022 occurred at a much faster pace than commonly believed. Over the past two decades, there had been a gradual decrease in its global market share, but in 2022, it lost market share at a rate ten times more rapid.
This substantial shift has largely gone unnoticed due to analysts traditionally calculating the nominal value of central banks’ dollar holdings without considering the changes in the dollar’s price. When accounting for these price changes, it becomes evident that the dollar has lost approximately 11 percent of its market share since 2016, and double that amount since 2008. The acceleration in the erosion of the dollar’s reserve currency status coincided with the onset of the Ukraine conflict.
It is reasonable to speculate that the main driver behind the dollar’s loss of reserve status in 2022 may have been concerns related to property rights. The year witnessed a moment resembling a global disagreement with the conduct of both Russia and the US, akin to a ‘defund-the-global-police’ sentiment among reserve managers worldwide.
Despite these developments, the US dollar remains the preferred international currency and retains its dominant role in global finance and trade. It is important to distinguish between these two concepts. While some countries in the Global South have shown reluctance to hold dollar assets, they still rely on the US dollar for international financial transactions.
To displace the US dollar as an international currency would depend on relative developments and stability in various financial markets. The dollar’s continued dominance is contingent on the resilience of its financial markets, which are characterized by their size, liquidity, and functionality. Although trends suggest a potential shift, it is not an imminent risk.
The US dollar continues to enjoy network advantages as an international currency, primarily due to its robust financial markets. However, the persistence of these advantages is not guaranteed. If the US makes policy errors and fails to engage in self-examination, there may come a time when much of the world actively seeks alternatives to the dollar.
Investors should be aware that while the Global South may not entirely avoid using the dollar, there is a growing reluctance to do so. This evolving landscape in global finance merits ongoing attention and analysis.
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