A reserve currency is one that governments and institutions hold in very large quantities to facilitate global transactions. Since the 1940s, the most widely accepted reserve currency has been the U.S. dollar (USD). Recently, there’s been a lot of press coverage suggesting the dollar could get dethroned, but the odds of this happening anytime soon are as close to zero as it gets.
A reserve currency must be both desirable and available. As of 2022, more than 88% of foreign exchange trading involved the dollar1, and nearly all commodities are priced in dollars. It also dominates as a payment currency for global trade with an 84% share of currency usage in value2,4. This dominance has also remained stable over the past 20 years.
Meaning, if a company in Malaysia wants to buy oil from Saudi Arabia, that transaction will be completed using dollars. Rewriting these contracts and redirecting so much international trade would take time and equal trust in a replacement currency.
Regarding availability, the USD currently represents 59% of all known central bank foreign exchange reserves3. The euro is in second place at 21%, so there is nowhere near enough euro in circulation, let alone any other currency, to replace the total value of dollars held.
For those who fear China’s currency will replace the dollar as the world’s reserve currency, the renminbi accounts for around 4.5% of international trade4 and 2.7% of central bank reserves3. Given China’s blatant manipulation and strict currency controls, it’s hard to envision how they could unseat the dollar.
Simply put, it took the U.S. several decades to create the level of trust and availability needed to become the world’s reserve currency, and there is little chance this will change anytime soon.
What about gold?
If paper currencies aren’t a threat to the dollar, what about gold? Some view this shiny pet rock as the one asset that has stood the test of time. Maybe that’s why tv commercials convincing viewers to buy gold have also spiked recently (or perhaps it’s because gold is up 20% since October5).
But gold produces no revenue, cash flow, or earnings. Nor does it pay dividends or reinvest back into itself. It’s just an asset that’s price is purely based on the demand to own it and the supply available rather than the value it creates. It’s as arbitrary as the price for art, Faberge eggs, sneakers, or Pokémon cards.
So, why would gold be a savior when it doesn’t do anything other than provide comfort to those who worship it? Doing so would be a wager that other investors are going to think the same way, and that’s a risky bet today versus periods like the 1970s.
Back then, it hadn’t been that long since gold was the standard for the U.S. dollar, and gold coins were more than just collectors’ items. Baby Boomers and the generations that preceded them grew up with gold as an integral part of their lives.
But it’s been decades since anyone used it to pay for anything. I’d even wager that younger generations view gold as a nuisance more than a savior. It’s heavy, hard to transport, expensive to insure, and you need special tools to carve it up to pay for stuff. There’s also another store of value these days called bitcoin, and unlike gold, it can be accessed on an iPhone.
The bottom line
This fear of the dollar losing its reserve currency status has become a Whac-A-Mole theory that won’t go away. It began with “we’ll never pay off all this government debt,” then morphed into “our kids will be speaking Mandarin,” and has now become page one material anytime the dollar weakens or a shift occurs in foreign policy.
For example, Saudi Arabia reportedly considered accepting yuan from China for payment for oil last year6. This ignited a wave of fear that the USD was on its way out as the preferred payment method for oil contracts across the globe. But China buys 25% of all Saudi oil. Perhaps Saudi Arabia was thinking of doing nothing more than catering to one of their top clients.
Furthermore, accepting a currency and keeping that currency are not the same. Unless China’s 4.5% of international trade were to grow exponentially over the next few years, Saudi Arabia would probably want to convert this monopoly money into something that can be used to pay for food and other imports. If so, the most readily available option today is the U.S. dollar.
To be clear, the dollar isn’t guaranteed to be the reserve currency forever. But it took eight decades for the USD to become the biggest and most trusted currency, so it would likely take just as long for an incumbent to unseat the dollar.
Herein lies the risk of taking headlines too seriously. Even if the fearmongers are right and the dollar is on its way out, it’s probably not happening in our lifetimes. Making investment decisions today to plan for something that could take decades to play out is inherently risky and could negatively impact a financial pan.
The bottom line is that pundits who proclaim the dollar is about to lose its reserve currency status are a lot like hypochondriacs. They will neither be convinced nor satisfied until we lose it. So, the next time this story receives airtime, the best course of action is simply changing the channel.
5 Bloomberg. As of 4/12/2023.
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