The state of the US dollar

The US dollar has held the status of the world’s dominant reserve currency since the signing of the Bretton Woods agreement in 1944.

Under this agreement, in an attempt to prevent a repeat of the protectionist monetary policies of the 1930s that led to a global depression, developed nations fixed the exchange rate of their currency against the US dollar. In turn, the US pegged the value of the dollar against gold and promised to exchange dollars for gold at any time. By being physically backed in this way, the US dollar provided central banks around the world with a liquid “hard” currency that they could hold in reserve to settle international trade accounts. Everyone would accept the dollar as a form of payment.

This regime finally collapsed in 1970, when the United States’ persistent trade deficit raised fears of a weak dollar and thus depleted its gold reserves. In today’s world of free-floating currencies, the role of foreign exchange reserves has changed. They are no longer held solely to pay for temporary imbalances in import and export imbalances, but are used as investment funds that also deter attacks by currency speculators.

Nonetheless, for the past several decades, the US dollar has remained by far the de facto major global reserve currency; 66% of the foreign exchange reserves of international central banks are held in US dollars. This reserve status also means that all major commodities are priced and traded only in US dollars and traders must purchase US currency to access commodities. Therefore, the question of whether the US dollar can maintain its privileged role as the main international reserve currency is key to assessing future demand and therefore its value.

In recent years, the size of US debt obligations (currently around 65% of GDP) and a persistent budget deficit (currently 11% of GDP), coupled with the emergence of the EU as the leading economy largest in the world, boosted the economic economy. commentators to question the sustainability of the dollar’s reserve status.

In 2007, former Federal Reserve Chairman Alan Greenspan stated that it was “entirely conceivable that the euro would replace the dollar as the reserve currency, or trade as an equally important reserve currency.” Similarly, at the World Economic Forum in 2008, George Soros opined: “The current crisis is not just the crash that follows the housing boom, it is basically the end of a 60-year period of continuous credit expansion based on the dollar as a reserve. badge”.

In January 2009, the Russian central bank announced that the euro share of its reserve assets increased to the level of 47%, surpassing investments in dollar assets that were 41%.

However, as contagion from the financial crisis continued to spread in late 2009 and fears about sovereign solvency in the EU and the strength of the economic recovery in the US took hold. “safe sky” assets, returned to the underperforming dollar. This inverse correlation between the strength of the dollar and investor confidence, the so-called “risk trade”, was summed up by the FT’s Martin Wolf: “In the recent panic, children ran to their mother even though their mistakes contributed so much to cause the crisis.”

So while central bank reserve managers remain nervous about the US fiscal position, they are essentially scrambling to find an alternative currency of choice. The sovereign debt crisis in the eurozone has thrown even the survival of the single currency into question, Britain’s financial position now looks even worse than the US’s, and Japan’s huge debts weigh heavily on the yen. . Shortview in the FT summed up the continued, if wavering, preference for the dollar: “Investors call it the ugly sisters problem: no one thinks the US dollar is Cinderella, but it’s probably the least objectionable of the bunch.”

So while the US dollar may be back in favor today, it appears to be for reasons of relative strength and short-term risk aversion, rather than a vote of confidence in long-term US economic fundamentals. However, whether there is a realistic alternative to turning central bankers away from the dollar and towards other reserve assets remains to be seen. The key questions that will drive the long-term value of the US dollar will be if, or when, this change in the status of the reserve could occur, and what the consequences will be for the US economy.

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