DOLLAR’S RESERVE CURRENCY APPEAL WANES AS COUNTRIES PUSH TO STABILISE TRADE
▶ Commodity markets at the mercy of exchange rate movements are seeking alternatives while others want to end US hegemony, experts tell
Last year, the US dollar was king. The world’s reserve currency had once again confirmed its status as the ultimate safe haven, crushing rivals such as gold, the Swiss franc, the Japanese yen and Bitcoin.
As the US Federal Reserve raised rates to fight inflation, overseas investors piled in as they sought a higher rate of return, driving the dollar to a 20-year high.
Then sentiment shifted as September drew to a close. Instead of fleeing trouble, investors started looking forward to the day when the Fed would declare victory in the war on inflation and begin to cut interest rates.
Falling US interest rates would turbocharge global stock markets as investors embraced risk again, while fleeing bonds. Anticipating this moment, the US Dollar Index – a measure of the value of the greenback against a weighted basket of major currencies – duly crashed, falling by 10 per cent from last autumn’s highs.
It staged a brief rally during the banking crisis amid investor fears of another banking meltdown, but has been sliding again in recent days.
A weaker dollar would be welcomed by many after last year’s dominance, including in the US, says Victoria Scholar, head of investment at Interactive Investor. “It could boost the US stock market by making the country’s exports cheaper to foreign buyers. Apple, Amazon, Tesla, Nike and others have all pointed to the greenback’s appreciation as a significant headwind for profitability.”
A dollar sell-off could also boost demand for oil, gold and other commodities that are priced in dollars and would be cheaper to holders of other currencies if the greenback fades.
This would boost the economies of emerging market countries such as Brazil and Mexico, which are heavily reliant on these exports, Ms Scholar says.
The strong dollar has been tough on emerging markets as it has driven up the cost of servicing their dollar-denominated debt. Such debt could now become more manageable if the dollar continues to weaken, giving emerging markets a further boost.
“Emerging market inflation rates may also fall as their own currencies strengthen against the dollar,” Ms Scholar says.
Currency values swing all the time but the dollar now faces a major long-term challenge to its reserve currency status. Not everybody likes playing by US rules. Russia and China would like to call a halt to the dollar’s hegemony – and they are not the only ones. In 2019, Mahathir Mohamad, Malaysia’s prime minister at the time, proposed the idea of a common trading currency for East Asia that would be pegged to gold.
At the start of millennium, about three quarters of global currency reserves were held in dollars. Today, that has fallen to 59 per cent, according to the International Monetary Fund, with the slide looking set to continue.
The dollar’s reserve currency status hands the US political power, as well as economic strength, and it has not been afraid to use it.
To punish Russia for invading Ukraine, western governments froze $300 billion of Russia’s foreign currency reserves last year, roughly half the total, and expelled Russian banks from the Swift international payments system. Dollar “weaponisation” has rattled many countries and not only Russia, says Jason Hollands, managing director of investment platform Bestinvest.
“Countries willing to continue to trade with Russia, like India and China, have started doing so in rupees and yuan instead, triggering talk of the de-dollarisation of the international trading order.”
Brazil and China are now trading with each other in yuan, helping to establish the yuan as an international currency and challenger to the dollar, especially in commodities, Mr Hollands says.
Dollar pricing makes life difficult for other countries because essentials such as oil become more expensive when the greenback rises, leaving the big commodity importers at the mercy of exchange rate movements.
“Strengthening economic ties and trade relationships between China and Russia are enhancing the yuan’s appeal because it offers them a more stable exchange rate,” says Vijay Valecha, chief investment officer at Century Financial.
The “petroyuan” would make big inroads in efforts to reduce the dollar’s dominance, Mr Valecha says.
“Even G10 nations are shifting away from the dollar and towards local currencies, as a safeguard against a soaring dollar and a US debt ceiling blow-up.”
Reports of the dollar’s death have been around for at least 50 years but this has yet to happen, says David Morrison, a senior market analyst at Trade Nation.
“However, the dollar is in a weaker position, with moves by China, Russia, Saudi Arabia and Iran to move away from pricing and trading energy in US dollars.”
The US dollar still dominates global trade, with about 90 per cent of foreign exchange trade involving the greenback.
It is hard to see the dollar losing its reserve status in the near to medium future, says Giles Coghlan, chief market analyst at HYCM.
“Yet, with some economists predicting that China’s GDP [gross domestic product] will outpace the US by 2030, the next decade will be crucial.”
If the dollar does lose its reserve status to the yuan one day, the subsequent drop in demand would hit the greenback hard and boost rival currencies such as the euro, Mr Coghlan says.
“In the US, borrowing costs would surge as demand for government bonds crumbles, while its substantial debt pile would also grow at pace.”
Politically, the impact would be even greater. “China would become the dominant global force,” he says.
The dollar’s strength has been built on US economic wealth, political stability, military might, rule of law, property rights and sophisticated financial systems, none of which are going to vanish overnight.
The yuan makes up only 7 per cent of global foreign exchange transactions – a small but fast-growing share, Mr Coghlan says.
“The global economy is hard-wired to the US dollar, but as China’s influence and power grows, that could change as more countries start using the yuan.”
“King Dollar” is a long way from losing its crown yet. However, after a century, it is finally facing a serious challenge to its power.