Will the U.S.Dollar Collapse?

There has been a long-term trend toward currency diversification in global financial transactions and trade. The U.S. dollar, however, is not losing its dominance any time soon.

There has been speculation lately that the U.S. dollar is on the verge of a major decline and might even lose its status as the world's major reserve currency. "De-dollarization," or the movement away from using the U.S. dollar as the primary currency of exchange in global trade and investment, has become a hot topic in financial circles. It appears to stem from news that China is beginning to use the yuan in commodity trades with a handful of trading partners. Brazil and Argentina are exploring the potential for a common currency. Extrapolating these trends, the argument is that demand for dollars will fall, sending its value steeply lower.

This argument is really overblown. A long-term trend toward diversification of currencies in global financial transactions and trade may develop. But that’s a big leap from dollar dominance to de-dollarization.

While the dollar has declined over the past six months, it remains close to a 10-year high versus currencies of countries with which the U.S. trades. It also remains the primary currency used for trade and financial transactions in the global economy. The size of the recent non-dollar transactions that have raised this alarm are very small. Trade in yuan accounted for less than 2% of global trade in 2022.

There are few signs that major foreign holders are poised to suddenly shift away from U.S. dollars. Very few other currencies could take its place as a reserve currency. A gradual move to a global economy with a less-dominant dollar is possible. And the dollar losing its reserve currency status is not likely in the very near future.

Higher interest rates boosted returns to dollarbased investors. The combination of stronger economic recovery and higher yields helped push the dollar higher. Foreign holdings of U.S. Treasury securities have grown since 2013, as shown in the chart

below:

Source: Bloomberg

International investment flows indicate that demand for U.S. dollars extends beyond U.S.

Treasury securities. With a resilient economy, the U.S. saw the largest inflow of foreign direct investment, long-term investment in businesses and property, of any major economy in 2022. Much of the increase in investment flows into the U.S. over the past few years has gone into equities.

Source: Bloomberg, monthly data as of 3/31/2023.

The dollar's position as the world's major reserve currency is periodically a source of concern among investors, even though its position hasn't changed much in decades. The dollar's share of global reserves has declined gradually over the past 20 years as central banks diversified their holdings, mostly into the euro since its introduction in 1999. Allocations of reserves to other currencies, such as the British pound and Canadian dollar, have gained modestly as well. Overall , however, the dollar still represents about 60% of global reserves, a modest decline from 67% 20 years ago.

While other major countries' markets have these qualities, the size and openness of the U.S. market is difficult to match. Europe's bond markets are more fragmented than the U.S. market although a movement toward euro-denominated sovereign debt issuance would provide a stronger base for it as an attractive alternative. Japan's bond market is closely controlled by its central bank, which owns the bulk of its government debt. China has capital controls, and its currency isn't even freely convertible. Giving up capital controls would mean that the government would relinquish control over investment flows and leave the currency susceptible to decline if domestic investors moved their money elsewhere.

Over the next six to 12 months, a moderate cyclical decline in the dollar is possible. The main driver is likely to be a greater convergence of interest rates in the major economies as the U.S. Federal Reserve nears the end of its rate hiking cycle

So, the YouTube podcasts and other media communication on the imminent collapse of the dollar is just drama or hype for now. But we in Malaysia should brace for a further rise in OPR to mitigate inflation and reduce the interest differential – that we leave to the wisdom of BNM.

Reference:

Will the U.S. dollar be dethroned? Kathy Jones, Bloomberg, 5 April 202