In the aftermath of the financial crisis, there was an effort to call time on the US dollar as the world’s most important currency.
The US mortgage crisis had spread to the rest of the world and caused a global recession because the world’s financial system was running on dollars. In 2010, the rest of the world said enough was enough. A United Nations commission issued a report saying that there needed to be “a new global reserve system” that didn’t rely on the US dollar as the single major currency. Earlier that year, French President Nicolas Sarkozy told political and business leaders gathered for the World Economic Forum in Davos, Switzerland that there should be a “new Bretton Woods” —referring to the post-war conference that pegged other major currencies to the dollar for several decades—that wouldn’t have a single primary reserve currency.
Eight years later, not much has changed. The US dollar remains the world’s foremost currency—by far. It accounts for more than 60% of global currency reserves held by central banks and nearly half of cross-border bank claims are denominated in dollars. But the greenback is facing a new wave of attacks on the global stage. This time, they aren’t routed in a financial crisis but in concern about the foreign policy of Donald Trump. The US president is accused of using the dollar as a weapon to push through a policy agenda and those on the losing side are calling for a change to the international monetary system.
At the UN General Assembly last week, the EU’s top diplomat Federica Mogherini announced a plan to set up a “special purpose vehicle” that would allow European companies to skirt US sanctions on Iran by creating a payment mechanism that doesn’t use America’s financial system and involve dollars. Determined to keep the 2015 Iran nuclear accord alive, Mogherini said “the dollar is not the only currency on earth—we have the euro, others have their own currencies.” The US’s decision to leave the accord has made Europeans “wonder what kind of autonomy we can have” without relying on the dollar, she said.
Recognizing that the global opinion is changing, Larry Fink, CEO of BlackRock, the world’s largest asset manager, said last week that the US’s move “from multilateralism to unilateralism” that “could lead to a deep desire to get another payment system” that could end in a “real dollar crisis.”
For decades, the US has enjoyed the “exorbitant privilege” of its reserve currency status. American companies can borrow cheaply thanks to international demand for US debt that keeps interest rates low and the government doesn’t have to worry about a balance-of-payment, or currency, crisis. In times of turmoil, money flows into the US and investors scramble for US Treasury bonds, deemed the world’s safest asset. All of this is at stake for the US if there was a meaningful change to the international monetary order. For the rest of the world, it could be a relief. Right now, Trump’s trade war with China has actually actually boosted US assets because people fear the economic consequences of the tariffs. And Trump’s revival of sanctions against Iran have proven to be so successful precisely because so many companies use the US financial system and have chosen to abandon their business with Iran rather than face Trump’s secondary sanctions.
While the dollar still the dominates, the latest data from the International Monetary Fund shows that its popularity is slipping. In the second quarter of 2018, 62.3% of the world’s $10.5 trillion in allocated reserves were in US dollars, the smallest share since 2013. It’s down from 62.5% in the previous quarter and 63.8% the year before. The decreases are small but part of a downward trend since the peak of nearly 73% in 2001. The share of reserves allocated to the Chinese yuan climbed in the past quarter from 1.4% to 1.8%, as European central banks started shifting US dollar reserves into the yuan.
The increase yuan reserves is meaningful, according to Steven Englander, the head of global G10 foreign-exchange research at Standard Chartered, because it happened even as the currency depreciated by more than 5%. It implies that more central bank reserve managers want the yuan as the currency becomes more important in trade and the Chinese government’s efforts to internationalize its currency are paying off. “This buying is probably long-term in nature,” he wrote in a note to clients.
A long-term shift away from the US dollar is what Jean-Claude Juncker, president of the European Commission, is hoping to instill as part of his legacy. Last month, in his final state of the union speech (pdf), Juncker said the commission would present initiatives to strengthen the international role of the euro by the end of the year. “The euro must become the face, the instrument of a new, more sovereign Europe,” he said.
The euro still has a long way to go to rival the dollar. Over the past decade its share in currency reserves has fallen from 26% to 20%, amid a sovereign debt crisis. But it is still early days for the shared currency. The dollar has been dominant for about seven decades but it’s been around for more than two centuries. The euro is is less than 20 years old.
The dollar will remain the de facto global reserve currency for “the foreseeable future” but further ahead there are reasons to see the dollar’s dominance waning, according to analysts at Moody’s. The increase in intra-regional trade and new reserve currencies like the yuan means countries won’t need to hold so much money in currencies from far afield. “Over time, this could presage less of a need to use the US dollar as the common denominator,” they wrote. If European institutions become stronger and more united, the euro’s appeal would increase too.
To speed the transition, major central banks—such as the European Central Bank, the Bank of Japan, and the Bank of England—would need to significantly increase their yuan reserves and do so by buying far more Chinese government bonds. Foreigners own just 1.7% of China’s local currency debt, according to Moody’s. That said, Trump’s isolationist policies are already spurring other governments to look for more ways to quickly insulate themselves from the dollar and the power it gives the US president.