Question:  

Will the U.S. dollar maintain its dominance as the world’s reserve currency?

Answer: 

A quick web search of this topic shows the debate has been going on for decades. The dominance of the U.S. dollar is used in approximately 88% of global transactions, and 60% of globally disclosed foreign exchange reserves are held in US dollars; the next closest is the Euro at 20%, according to FactSet data as of April 4, 2023. 

There have been rumors and whispers that the Chinese renminbi (RMB) may overtake the dollar as the world reserve currency. According to economist Peter Earle, "Even beyond the decades that such a change would probably take, the likelihood of the yuan becoming the global reserve currency ranges between profoundly unlikely to essentially impossible." The obvious dominance of the U.S. dollar in trade is one reason.

In China, the country’s capital account is not open or liberalized. This means that if you hold RMB, you are not free to use your RMB to buy Chinese assets in China. You can buy dinner if you’re in China, but you can’t buy a factor or an asset. In contrast, in the early 1990s, a Japanese billionaire bought the Empire State Building in New York City. This happened because since the 1960s there had been a large trade surplus with Japan, meaning Japan accumulated U.S. dollars (we sent more dollars to them for goods than they sent back).

Japanese individuals can buy U.S. assets because the U.S. capital account is liberalized. That’s not the case in China, so if a foreigner holds RMBs, they can not freely purchase Chinese assets. China’s government must enter into bilateral swap lines (BSLs) with other countries to guarantee payments. BSLs are subject to China’s discretion and control. This is their way of developing an alternative payment system and not having to liberalize their currency. If China were to liberalize their currency, they’d be at the mercy of international capital flows and market forces, losing its grip on the economy. In summary, the U.S. dollar is a freely trading currency while the Chinese RMB is not because the Chinese government determines the value of its currency.

On January 1, 1999, the European Central Bank launched the euro to promote economic growth and cooperation between European countries. The euro strengthened and reached $1.58/euro in 2008. Since then, it’s weakened and is currently trading at $1.09/euro. Reasons for this include debt crises in multiple Eurozone countries, slowed growth, political uncertainty, and the lack of a fiscal union. Eurozone countries are fundamentally different, both culturally and economically.

Remember BRICs? This stands for Brazil, Russia, India, and China. There’s talk that the BRICs would like to create a financial pact to increase their power. The different objectives, views, and levels of strength between these countries make it unlikely that they could successfully accomplish such an undertaking.

Although China is clearly the strongest of the BRICs, it’s a Communist regime, has a non-convertible currency, maintains inefficient state-controlled industries, and has an aging and declining population. For these reasons, it’s an unlikely candidate as holder of world reserve currency. Uniting with the other three counties does not add a great deal of confidence toward attaining global currency status. 

Brazil is a large exporter of commodities and natural resources; they suffer with high unemployment and political instability. While some European countries remain energy dependent on Russia, it can be argued that the long-term prospects for Russia don't look very promising. India is the sixth largest economy in the world, yet is known for significant corruption, income inequality, still-developing infrastructure, and a caste system that hinders economic development. 

China is the second largest economy in the world and the RMB only represents about 3% of the share of global currency reserves while the U.S. dollar represents 60% of this measure. For these reasons, it’s unlikely that a manipulated, non-convertible Chinese currency can compete with the U.S. dollar. The U.S. dollar is a vital part of the global economy and will likely remain as the lead dog in the global economy. Stay focused and plan accordingly.