We are often asked if the U.S. dollar will lose its status as the world’s reserve currency. Investors are concerned that the Federal Reserve’s easy monetary policy, combined with rising budget deficits, will undermine confidence in the dollar. The recent drop in the dollar over the past year has heightened these concerns. While we agree that there can be unforeseen consequences from the current policy mix, we believe the dollar’s role as the dominant global currency looks secure.
What are reserve currencies?
Reserve currencies are typically issued by large, developed countries with records of financial stability. To be held in reserve by a foreign central bank, a currency typically needs to:
- be freely convertible (not pegged by the government);
- have a large and liquid debt market that foreign investors can access;
- have an independent central bank;
- and be widely used in trade and global transactions.
In addition to the U.S. dollar, the euro, the Japanese yen, British pound, Swiss franc, Australian dollar, and Chinese renminbi are all held in reserve. However, the dollar is by far the most widely held currency at 60% based on 2020 data from the IMF.
Foreign exchange holdings as a percentage of total allocated in U.S. dollars
Source: Bloomberg. Foreign Exchange Holdings as a Percentage of Total Allocated in U.S. Dollars, Euro, Yen, Renminbi, and Other Reserve Currencies. Currencies represented in “Others”: Swiss Franc, Canadian Dollar, Australian Dollar, Great British Pound, and unclassified others (CCFRUSD% Index, CCFREUR% Index, CCFRJPY% Index, CCFRCNYP Index, CCFROTR% Index, CCFRCHF% Index, CCFRCADP Index, CCFRAUDP Index, CCFRGBP% Index). Quarterly data as of 12/30/2020.
The U.S. dollar is also used in about 40% of global trade and nearly 80% of all global cross-border transactions. Most commodities and many other goods are traded in U.S. dollars—oil, copper, and agricultural goods—to name a few. Investors need to hold dollars to trade in goods and services, and need to have a large and liquid bond market to in which to invest those dollars.