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As anyone familiar with the most exciting parts of the financial blogosphere can tell you, the dollar is on an unstoppable trajectory toward disaster.
A recent publication argued that the United States, like the Roman Empire before it, It weakened in relation to other world powers.. The central role of the dollar in the global financial system is in decline as “the people in charge never seem to miss the opportunity to dismantle capitalism brick by brick.”
That’s the argument. We have all heard it for more than two decades and we will hear it again, now with the added touch of dark geopolitical trends; The move in 2022 to punish Russia for its large-scale invasion of Ukraine by freezing its foreign dollar reserves means that many countries could now try to hide their emergency funds in other currencies.
A global effort – coordinated or not – to debase the dollar could occur. If implemented on a large scale, it would eliminate the United States’ exorbitant privilege to issue debt on its own terms, with the assurance that other national authorities will accept it. This would be a game changer in markets and commerce. But the evidence suggesting this is already happening is limited at best.
The proportion of global central bank reserves held in Dollars has decreased in recent decades. In 2016, the currency represented more than 65 percent of official reserves, according to IMF data. By the end of 2023, that figure had dropped to 58.4 percent. The amount held in Chinese renminbi at the beginning of 2016 was zero. Between the end of that year and 2023 it increased by 188 percent. But while it may seem huge, it’s still only a sliver of 2.3 percent of the total.
However, a recent blog from the New York Federal Reserve argues that the dollar’s apparent decline is not due to a global cooling of the dollar. Rather, the change is attributable to a small number of countries, including Switzerland, where a long-standing effort to keep the franc low just over a decade ago led to a huge accumulation of euros. “In fact, the increase in the share of the US dollar between 2015 and 2021 was a feature of 31 of the 55 countries for which estimates exist,” say economists at the New York Federal Reserve. wrote at the end of May. “The decline in dollar preferences of a small group of countries – notably China, India, Russia and Turkey – and the large increase in the amount of reserves held by Switzerland explain most of the decline in the aggregate share of reserves in dollars”.
Meanwhile, central banks around the world have increased purchases of gold, in an apparent effort to avoid the risk of sanctions, since gold is not controlled by any national authority. However, as the New York Federal Reserve emphasizes, even after a rapid accumulation of gold in 2022 and 2023, the precious metal still represents a relatively modest 10 percent of total global reserves. Narratives about the dollar’s declining share and gold’s rising role “inappropriately generalize the actions of a small group of countries,” he says.
In fairness to dollar doomsayers (who tend to overlap significantly with gold enthusiasts and the cryptocurrency curious), gold holdings appear poised to rise even further. A survey of reserve managers by the Forum of Official Monetary and Financial Institutions think tank said that despite record gold prices and moderating global inflation, so Gold is often seen as a hedge.Reserve managers are interested in increasing their holdings of the metal.
However, demand for dollars remains extremely strong. This survey does not cover all countries, but it does cover 73 central banks, with a combined fund of $5.4 trillion. Of those, OMFIF said a net 18 percent expect to increase rather than decrease their allocation to the dollar, attracted by higher interest rates and a robust U.S. economy. The euro is the next most popular currency on the wish list, suggesting reserve managers are keen to stick with larger, more liquid currencies.
Meanwhile, appetite for the renminbi “has soured,” OMFIF researchers said, and 12 percent of managers are looking to trim their holdings in the Chinese currency. This is a big change of heart. In 2021 and 2022, almost a third were looking to increase their renminbi holdings.
“This is partly due to relative pessimism about the near-term economic prospects in China, but the vast majority also cited market transparency and geopolitics as deterrent factors. . . ”states the report of the expert group.
Nothing lasts forever. It is not impossible to imagine, in the current political climate, a deterioration in US institutional resilience that ends up posing a serious threat to the long-term position of the dollar. But two decades ago it seemed premature to end the dollar’s primacy in the global financial system, and it still seems that way now.