Is the U.S. Dollar’s Dominance Under Threat?

The U.S. dollar has long dominated global trade and finance. It serves as the primary medium to buy and sell goods, as well as a safe haven for foreign reserves for financial institutions and businesses around the world.

Its dominant status gives the U.S. some big economic advantages. Because international trade is largely denominated in U.S. dollars, U.S. companies and consumers are generally less likely than their international peers to face foreign-exchange transaction costs or risks from shifting exchange rates. In addition, strong global demand for dollar-denominated U.S. securities, such as Treasury bonds, historically has allowed the U.S. government to borrow at relatively low interest rates to fund its spending needs.  

Emerging Concerns

However, some investors fear that the U.S. dollar might lose the primacy it has held since supplanting the British pound as the world’s top reserve currency after World War II. Recently, such concerns have flared up amid geopolitical tensions that may bolster other currencies, such as the euro, the Chinese renminbi or even a proposed common currency among the so-called BRICS nations of Brazil, Russia, India, China and South Africa.

The idea of “de-dollarization” has been on the radar for at least 20 years—and, indeed, the dollar’s share of reserve currencies has gradually declined as foreign central banks have diversified. In theory, increased competition from other currencies could hurt demand for the U.S. dollar, potentially causing its value to decline in foreign-exchange markets and reversing some of the advantages its dominance has conferred on U.S. institutions and investors.

Threats Seem Exaggerated

However, the U.S. dollar’s incumbent role in the global economy is unlikely to be seriously challenged any time soon for four key reasons:  

• The U.S. dollar remains the world’s dominant “medium of exchange,” or means of buying and selling goods. In March, for instance, the Society for Worldwide Interbank Financial Telecommunication (SWIFT) reported that the U.S. dollar was the most commonly used currency on its global payment system, accounting for 41.7% of payments, followed closely by the euro. By comparison, the Chinese renminbi was used in 2.4% of SWIFT payments, despite China accounting for a relatively larger percentage of global trade.

• The dollar also remains the primary “unit of account” globally, meaning it serves as the standard way that trading partners measure the market value of goods and services being exchanged. According to the Federal Reserve, from 1999-2019, the U.S. dollar accounted for 96% of trade invoicing in the Americas, 74% in the Asia-Pacific region and 79% in the rest of the world. The only exception was in Europe, where the euro is the primary invoicing currency, given frequent trading between EU partners.

• The U.S. dollar is widely viewed as a reliable “store of value,” or safe haven. In large part because of this stability relative to other currencies, the greenback accounts for nearly 60% of foreign reserves (i.e., the currencies held by central banks to help manage their nation’s monetary system and exchange rate). While the U.S. dollar’s share of central bank reserves has declined over time, it still dwarfs the shares of all competitors. What’s more, according to the Brookings Institution, more than 65 countries peg their currency to the U.S. dollar.

• There is currently no viable alternative. Other currencies have been discussed as potential competitors to the U.S. dollar, but none comes close to posing a credible threat—at least, not yet. 
  •  The euro is the world’s second-largest reserve currency, but ranks a distant second, accounting for 21% of foreign reserves versus the dollar’s nearly 60%. Key factors inhibiting the euro’s broader use: According to the National Bureau of Economic Research, there is an inadequate supply of high-quality, euro-denominated assets that international investors and central banks can use as a store of value, and no eurozone-wide “safe” government-backed asset. 
  • China’s renminbi accounts for a very small portion of foreign exchange reserves, and Chinese policymakers’ control over the exchange rate makes it unlikely to quickly gain traction.
  • Gold is time-consuming and expensive to move, thus making it less than ideal as a medium of exchange or unit of account.
  • A BRICS common currency is still very hypothetical. BRICS nations may find it challenging to coordinate across central banks and could ultimately prove unwilling to exchange their U.S. dollar reliance for a potentially volatile currency that could struggle to achieve broader adoption.

Given these circumstances, it would be hard to break away from the dollar-centric system. It is entirely possible that multiple major reserve currencies will emerge, based on trading relationships—for example, the euro in Europe, the renminbi in Asia and the U.S. dollar in the Americas—but it would likely take decades to fully supplant the global primacy of the dollar.

Interested in learning more? Ask your Morgan Stanley Financial Advisor for a copy of the Global Investment Office report, Is the US Dollar’s Dominance Under Threat? Listen to an audiocast based on the report. Your Financial Advisor can also help you understand how exposure to different markets and currencies may impact your portfolio.