Introduction
Since the end of World War II, the dollar has been the world’s most important means of exchange. It is the most commonly held reserve currency and the most widely used currency for international trade and other transactions around the world. The centrality of the dollar to the global economy confers some benefits to the United States, including borrowing money abroad more easily and extending the reach of U.S. financial sanctions.
But some experts argue that high foreign demand for dollars comes at a cost to export-heavy U.S. states, resulting in trade deficits and lost jobs. Meanwhile, the dollar’s dominance could be at risk. Many emerging economies have increasingly sought ways to conduct trade in non-dollar currencies, a process known as de-dollarization, especially given the fallout from the Russian invasion of Ukraine and the repercussions of the COVID-19 pandemic. Yet, few serious contenders have emerged, making it unlikely that the greenback will be replaced as the leading reserve currency anytime soon.
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What is a reserve currency?
A reserve currency is a foreign currency that a central bank or treasury holds as part of its country’s formal foreign exchange reserves. Countries hold reserves for a number of reasons, including to weather economic shocks, pay for imports, service debts, and moderate the value of their own currencies. Many countries cannot borrow money or pay for foreign goods in their own currencies—since much of international trade is still done in dollars—and therefore need to hold reserves to ensure a steady supply of imports during a crisis and assure creditors that debt payments denominated in foreign currency can be made.
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By buying and selling currencies on the open market, a central bank can influence the value of its country’s currency, which can provide stability and maintain investor confidence. For instance, if the value of the Brazilian real starts to fall during an economic downturn, the Central Bank of Brazil can step in and use its foreign reserves to bid up its value. Conversely, countries can intervene to stop their currencies from appreciating and make their exports cheaper.
Most countries want to hold their reserves in a currency with large and open financial markets, since they want to be sure that they can access their reserves in a moment of need. Central banks often hold currency in the form of government bonds, such as U.S. treasuries. The U.S. treasury market remains by far the world’s largest and most liquid—the easiest to buy into and sell out of—bond market.
The International Monetary Fund (IMF), the body responsible for monitoring the international monetary system, recognizes eight major reserve currencies: the Australian dollar, the British pound sterling, the Canadian dollar, the Chinese renminbi, the euro, the Japanese yen, the Swiss franc, and the U.S. dollar. The U.S. dollar is the most commonly held, making up 59 percent of global foreign exchange reserves.
As of July 2023, China has by far the most reported foreign currency reserves of any country, with more than $3 trillion. Japan, in second place, has around $1.1 trillion. India, Russia, Saudi Arabia, Switzerland, and Taiwan also have large reserve holdings. The United States currently holds roughly $244 billion worth of assets in its pool of reserves, including $36 billion worth of foreign currencies.
How did the U.S. dollar become the world’s leading reserve currency?
The dollar’s status as the global reserve currency was cemented in the aftermath of World War II by the 1944 Bretton Woods Conference, in which forty-four countries agreed to the creation of the IMF and the World Bank. (Some economists argue that the dollar had overtaken the British pound [PDF] as the leading reserve currency as early as the mid-1920s, while others argue that the dollar is the first true reserve currency.) At Bretton Woods, a system of exchange rates was created wherein each country pegged the value of its currency to the dollar, which itself was convertible to gold at the rate of $35 per ounce. This was designed to provide stability, and prevent the “beggar-thy-neighbor” currency wars of the 1930s—a response to the Great Depression—by which countries abandoned the gold standard and devalued their currencies to try to gain a competitive advantage.
By the 1960s, however, the United States did not have enough gold to cover the dollars in circulation outside the United States, leading to fears of a run that could wipe out U.S. gold reserves. Following failed efforts to save the system, President Richard Nixon suspended the dollar’s convertibility to gold in August 1971, marking the beginning of the end of the Bretton Woods exchange rate system. The Smithsonian Agreement, struck a few months later by ten leading developed countries, attempted to salvage the system by devaluing the dollar and allowing exchange rates to fluctuate more, but it was short-lived. By 1973, the current system of mostly floating exchange rates was in place. Many countries still manage their exchange rates either by allowing them to fluctuate only within a certain range or by pegging the value of their currency to another, such as the dollar.
The Global Role of the U.S. Dollar
The U.S. dollar is still king today, despite recent challenges. In addition to accounting for the majority of global reserves, the dollar remains the currency of choice for international trade. Major commodities such as oil are primarily bought and sold using U.S. dollars, and some major economies, including Saudi Arabia, still peg their currencies to the dollar.
Factors that contribute to the dollar’s dominance include its stable value, the size of the U.S. economy, and the United States’ geopolitical heft. In addition, no other country has a market for its debt akin to the United States’, which totals roughly $22.5 trillion. “It’s more helpful to think of U.S. treasuries as the world’s leading reserve asset,” says CFR’s Brad W. Setser. “It’s hard to compete with the dollar if you don’t have a market analogous to the treasury market.”
The dollar’s status as the leading reserve currency has been called the “exorbitant privilege” of the United States.
What are the benefits for the United States?
The dollar’s status as the leading reserve currency has been called the “exorbitant privilege” of the United States, a phrase coined by former French Finance Minister Valery Giscard d’Estaing in the 1960s. At the time, French officials believed that the world’s appetite for dollars provided cheap financing for U.S. investment abroad. Over time, U.S. trade swung into a sustained deficit, supported in part by global demand for dollar reserves. Such demand helps the United States to issue bonds at a lower cost, since higher demand for a government’s bonds means it doesn’t have to pay as much interest to entice buyers, and helps to keep the cost of the United States’ now substantial external debt down.
Some experts say this benefit is modest, pointing to the fact that other developed countries are able to borrow at similarly low rates. Former Federal Reserve Chair Ben Bernanke has argued that the United States’ declining share of the global economy and the rise of other currencies such as the euro and yen have eroded the U.S. advantage. “The exorbitant privilege is not so exorbitant any more,” Bernanke wrote in 2016.
The dollar’s centrality to the system of global payments also increases the power of U.S. financial sanctions. Almost all trade done in U.S. dollars, even trade among other countries, can be subject to U.S. sanctions, because they are handled by so-called correspondent banks with accounts at the Federal Reserve. By cutting off the ability to transact in dollars, the United States can make it difficult for those it blacklists to do business. For example, in the wake of the Russian invasion of Ukraine in 2022, unprecedented U.S. sanctions cut Russia off from the dollar, freezing $300 billion in Russian central bank assets and triggering a default on the country’s sovereign debt. “There’s no doubt that if the dollar were not so widely used, the reach of sanctions would be reduced,” says Setser.
However, some experts, including U.S. Treasury Secretary Janet Yellen, say that the aggressive use of sanctions could threaten the dollar’s hegemony. (Other economists dispute this). “Sanctions are an effective tool, but we have to be careful,” CFR’s Benn Steil told NPR. “It’s like over-prescribing an effective antibiotic. It encourages the development of new strains of bacteria that are resistant to the antibiotic.” Following Russia’s invasion of Ukraine, an increasing number of countries, including U.S. partners such as India, have explored ways to continue trading with Russia that don’t involve the dollar. Meanwhile, the Chinese renminbi has become the most-traded currency in Russia.
Is de-dollarization happening?
The economic upheaval caused by the pandemic and the war in Ukraine has renewed concerns about the downfall of the dollar as the leading reserve currency. Previous predictions about the dollar’s demise, including after the 2008 financial crisis, have not come to pass, but some economists say that the dollar’s role in the international financial system should not be taken for granted, because there are economic and geopolitical incentives for other countries to de-dollarize.
“China does not have the intention or the capacity to dethrone the dollar.”
Zongyuan Zoe Liu, CFR Expert
Indeed, some countries are increasingly pushing back against the dollar. At an April 2023 summit of BRICS countries (Brazil, Russia, India, China, and South Africa), Brazilian President Luiz Inácio Lula da Silva asked, “Why can’t we do trade based on our own currencies?” However, the most commonly suggested alternatives have their own problems:
BRICS currency. For years, leaders of BRICS countries have discussed a framework for a shared currency, with proponents arguing that it would protect against devaluation when the dollar rises. However, experts point out that structural challenges in BRICS countries, including a lack of robust central banks and monetary policies, make it infeasible.
Euro. The euro is the second most used reserve currency, accounting for roughly 20 percent of global foreign exchange reserves. The European Union rivals the United States in economic size, exports more, and boasts a strong central bank and robust financial markets—factors that make its currency a viable challenger to the dollar. But the lack of a common treasury and a unified European bond market limits its attractiveness as a reserve currency, according to Setser.
Renminbi. China has been trying to boost the global role of the renminbi, also known as the yuan, since the late 2000s. It currently accounts for 3 percent of global reserves, but China has increasingly pushed to use the renminbi in bilateral trade, especially in the wake of the Ukraine war. However, Chinese policymakers are wary of the lessons from previous currencies [PDF] that rapidly internationalized, and they have imposed strict controls on the flow of money that have hamstrung the renminbi’s growth. “China does not have the intention or the capacity to dethrone the dollar,” says CFR’s Zongyuan Zoe Liu.
Special Drawing Rights (SDR). During the Bretton Woods talks, British economist John Maynard Keynes proposed the creation of an international currency, the “bancor,” which would be administered by a global central bank. While Keynes’s plan never came to fruition, there have been calls to use the IMF’s Special Drawing Rights (SDR) —an internal currency that can be exchanged for hard currency reserves—as a global reserve currency. The value of SDR is based on five currencies: the euro, pound sterling, renminbi, U.S. dollar, and yen. Proponents argue that such a system would be more stable than one based on a national currency whose issuer must respond to both domestic and international needs.
But for SDR to be adopted widely, economists say it would need to function more like an actual currency, accepted in private transactions with a market for SDR-denominated debt. The IMF would also need to be empowered to control the supply of SDR, which, given the United States’ de facto veto power within the organization’s voting structure, would be a tall order.
Cryptocurrencies. Tech evangelists dream of a world where cryptocurrencies such as Bitcoin replace government-backed currencies. Such digital currencies are “mined” and transferred via a decentralized network of computers without any issuing authority. Proponents—including El Salvadoran President Nayib Bukele, who has made Bitcoin legal tender—argue that such a system would free countries from the whims of other nations’ monetary policies. But critics say adopting cryptocurrency as legal tender constrains a government’s policy options during a crisis, and that the volatility of cryptocurrency reduces its viability as a means of exchange. However, some countries are experimenting with using blockchain technology to create digital versions of their existing traditional currencies.
Are there costs to dollar dominance?
A highly valued dollar makes U.S. imports cheaper and exports more expensive, which can hurt domestic industries that sell their goods abroad and lead to job losses. This imbalance can worsen during times of financial turmoil, when investors seek the stability inherent to the dollar. Some analysts argue that the cost of the dollar’s dominance for manufacturing-heavy U.S. regions such as the Rust Belt are too high, and that the United States should voluntarily abdicate. Other economists disagree, arguing that there will always be winners and losers with a strong dollar. These experts contend that losses for exporters are countered by gains for importers, and that overall, the situation is a net benefit to the U.S. economy.
“Both the United States and the world at large would benefit from a less dominant U.S. dollar.”
Michael Pettis, Professor of Finance, Peking University
Meanwhile, the dollar’s outsize role in international trade could have negative consequences for the global economy. As a country’s currency weakens, its goods exports should become cheaper and thus more competitive. But because so much trade is conducted in U.S. dollars, other countries do not always see this benefit when their currencies depreciate. “Both the United States and the world at large would benefit from a less dominant U.S. dollar,” writes Michael Pettis, a professor of finance at Peking University.
The United States is also harmed by currency manipulation—when another country holds down the value of its currency to maintain a large trade surplus. If a country keeps the value of its currency artificially low by accumulating dollar reserves, its exports will become more competitive, while U.S. exports will become comparatively more expensive. China has historically been among the worst offenders, though most experts agree that it has not been heavily intervening to hold its currency down in recent years. The COVID-19 pandemic led to a resurgence in currency manipulation, with advanced economies such as Switzerland and Taiwan buying dollars, euros, and other reserve currencies to depreciate their own.
What is in the dollar’s future?
Many experts agree that the dollar will not be overtaken as the world’s leading reserve currency anytime soon. More likely, they say, is a future in which it slowly comes to share influence with other currencies, though this trend could be accelerated by the aggressive use of U.S. sanctions and growing U.S. financial instability.
Some economists say that the dollar playing a smaller global role is nothing to fear, and that it would in fact benefit the United States, as long as the dollar remains the global reserve. Economist C. Fred Bergsten argues that low interest rates resulting from the dollar’s unique status encouraged American profligacy and contributed to the 2008 financial crisis. He advocates for a greater role for the euro and renminbi, as well as for SDR.
However, if the dollar were to lose its reserve status, the United States would feel serious economic and political repercussions, Liu warns. Without dollar dominance, the country would lose the capacity to borrow quickly and cheaply, potentially damaging its ability to fund industrial policy or social welfare programs. De-dollarization would also rewrite the rules of the global financial system, which, under the leadership of the dollar, is guided by U.S. values. Under a non-dollar system, “the rules, the values, would be absolutely different,” Liu says. “We don’t want to do business with child labor or human rights abuses. But in a different system, perhaps some of those values would be more likely to be ignored, rather than preserved.”