14 July 2023
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The outlook for dollar dominance

US dollar dominance is likely to continue for now, but over the longer-term it appears plausible that a more diversified set of reserve currencies may emerge.

By Edward Bell

  • The US dollar has served as the world’s dominant reserve currency since the Second World War, but a de-dollarization narrative has seen a resurgence in recent months.
  • Several pieces of economic data can provide an insight into whether there has been a change in the desire to hold or use US dollars, including its share in reserves held by central banks, its share in currency trading and the role played by the dollar in offshore funding markets.
  • While there has been a shift in dollar reserve holdings since the early 2000s, the US dollar still accounts for almost 60% of reserves held by central banks.
  • Beyond forex reserves, the US dollar is also dominant in currency trading, accounting for 88% of total turnover in 2022, relatively unchanged since 2004.
  • The US dollar additionally plays an outsized role in offshore funding markets, with around half of international debt securities and cross-border loans being US dollar denominated.
  • These three measures suggest that the dollar’s prime position appears largely unchallenged, thus far.
  • But there are developments that may yet drive a longer-term shift away from the US dollar, including the use of sanctions as a US foreign policy tool. There has also been a rise in bilateral agreements to settle trade in local currencies rather than the US dollar.
  • Despite a potential longer-term desire amongst some economies to diversify away from the dollar, there are also some fundamental stumbling blocks that may slow or limit this process.
  • In particular, recent work by the IMF suggests that there is significant inertia in reserve currency status, with a strong bias to using whichever reserve currency has been dominant in the most recent past.
  • One possible reason for this inertia may be the US dollar’s safe-haven status, evident in the perennial demand for US government bonds, even during times when there is heightened risk within the US economy itself.
  • There is also a lack of feasible alternatives, with both the euro and the yuan facing their own issues as real challengers to the dollar.
  • Apart from traditional currencies becoming more important, there has also been speculation that unconventional alternatives could be used as a global reserve currency, including crypto and central bank digital currencies (CBDC). But the characteristics of these alternatives mean that they are unlikely to re-order currency dominance in of themselves.
  • In the near-term US dollar dominance is likely to continue, but over the longer-term it appears plausible that a more diversified set of reserve currencies may develop.
  • Ultimately the pace of diversification in central bank reserves and the choice of currency for trade and cross-border debt settlement will be contingent on developments in these alternate currency regimes, such as increased liberalization of China’s capital account. Trust in the institutions, policy predictability and robust regulatory frameworks in the issuing country will also be key to the emergence of dollar alternatives. 
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Written By

Edward Bell Head of Market Economics

Jeanne Walters Senior Economist

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Edward Bell

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