The U.S. dollar remains the world’s reserve currency
Over the past year and until the current Iran war, the United States dollar has offered a mixed picture in two respects. Its exchange rate has weakened against the euro and the British pound (from 0.95 to 0.85 and from 0.79 to 0.74, respectively), but strengthened against the yen (from 150 to 155). At the same time, its role as the world’s reserve currency has inched a tad lower, from about 58 percent to 56 percent (it was about 60 percent in the mid-1990s and peaked at 70 percent in 2000), but it still is preferred to all other currencies by a wide margin. The shares of the euro and of the renminbi as reserve currencies are about 20 percent and 2 percent, respectively.
The world’s primary reserve asset other than fiat currencies is gold, the price of which increased about 65 percent in dollar terms during the past year. Despite frequent reports about large purchases by central bankers, the physical amounts held in central bank vaults have increased by only about 3 percentage points.
The role of the dollar as the dominant reserve currency is therefore not in doubt, despite the events and initiatives that recently were intended to weaken its role. The cryptocurrency phenomenon and the efforts to create renminbi and BRICS currency areas exemplify these failed attempts. Moreover, although the dollar has suffered from America’s declining share of world trade – from about 18 percent in 2000 to roughly 12 percent in 2025 – during the past two decades it has remained by far the dominant currency used in international trade.
A tired dollar and the alternatives
Certainly, the dollar is not in very good shape. It is not a strong currency (it has lost about 20 percent of its purchasing power since January 2020); non-U.S. buyers of dollar-denominated public debt are looking for alternatives; American stocks are perceived as expensive and investors are showing growing interest toward other markets to rebalance their portfolios. The somewhat erratic behavior of the current U.S. administration is also a source of concern.
The alternatives to the dollar are still limited to gold and the euro. Since antiquity, gold has been a safe asset. Financial shakeups, political tensions and wars have always rewarded individuals and rulers who had large gold reserves (especially when stored in safe locales).
Yet, today’s problem with gold is volatility. Although its price variability is similar to that experienced by stocks and lower than that of cryptocurrencies and other metals, it is greater than that of dollar- or euro-denominated bonds. Volatility has consequences. It discourages bureaucrats from buying gold for fear of being held responsible if prices stagnate or drop. Long-term trends do not matter. Bureaucrats’ timelines and motivations are limited; central bankers are not rewarded when prices go up, but are likely to be blamed when they move in the opposite situation.
At the same time, volatility discourages exporters and importers from using gold as a pricing unit. The jewelry and electronics industries do not command enough of the market to stabilize prices. In short, volatility sets a limit to the potential total addressable market for gold.
While gold is attractive for central bankers in diversifying their portfolios, it can play a significant role as a reserve asset only if financial and currency markets feature heightened uncertainty and are likely to experience serious crises.
On paper, the euro could be a credible substitute for the dollar as a reserve currency and expand its role significantly. European Central Bank President Christine Lagarde made this very point less than a year ago. Rather surprisingly, she emphasized that global demand for euros could surge if Europe’s military power increased and European Union authorities were allowed to engage in financing safe assets, possibly coded language for public investment initiatives with ECB guarantees of some sort.
If Ms. Lagarde’s preconditions are met, however, the very opposite is likely to happen. Investors do like governmental guarantees. However, they do not trust highly regulated economies where political accountability is uncertain and central bankers engage in reckless monetary policy and may be forced to rescue troubled companies and governments.
That the euro area is the source and destination of large trade flows is not enough to ensure that its currency attracts financial investors from beyond. It does not make certain that the euro is used as the standard unit of exchange in international business transactions, nor that it will become a serious rival to the dollar.
The reasons the dollar has lost much of its appeal is because of U.S. monetary policy, unpredictable policymaking and the country’s increasingly high public debt. Other currency areas, however, have not done much better. The euro suffers from the poor condition of the European economy (devastating regulation and technological backwardness) and the renminbi from China’s political and economic rules (unrestrained arbitrary power and strict capital controls).
The only alternatives to the lackluster fiat currencies are cryptocurrencies and gold, the former characterized by illiquid markets, prohibitive volatility, lack of collateral and no yield; the latter also by high volatility and no yield.
Scenarios
In the end, central bankers may not love the dollar, but none of them have a better alternative. As such, three scenarios may unfold in the next few years, with the U.S. dollar maintaining its preeminence still the most likely.
Most likely: The dollar remains the primary reserve asset while gold keeps rising
The most likely development hinges on central banks significantly diversifying their foreign-asset portfolios. Because the euro and the renminbi are not perceived as safe havens, interest rates on euro-denominated bonds are unappealing and cryptocurrencies are illiquid and volatile, the only option is to keep the bulk of reserves in dollars while gradually diversifying into gold.
The overall demand for gold will then rise. This is both because central bankers want to diversify, and because international tensions and widespread uncertainty in financial markets will encourage private investors to increase the share of gold in their portfolios as well (on average gold currently accounts for less than 10 percent of their portfolios).
Rising, demand-driven gold prices will pause only when central bankers and financial investors reach their particular goals. We can expect that demand for dollars will grow at a slower pace than that of gold, and that the U.S. currency assuredly remains the dominant reserve asset.
Less likely: The euro eats into the dollar’s position as European policy improves
A less likely scenario of the euro growing as a reserve asset depends on two drastic changes occurring. One would involve Frankfurt’s monetary policy, whereby the ECB credibly commits to stop manipulating interest rates and to freezing the monetary base (currency in circulation plus the reserves of the commercial banks at the central bank).
A second change concerns the Eurobond market, which is currently little more than local. It represents less than 20 percent of the world’s bond market (EU gross domestic product is about 15 percent of global GDP) and 97 percent of the issuers belong to the euro area. Military commitments, green-transition projects and bureaucratic engagement in technological ventures will not change the picture. A reliable currency depends on a healthy economy with a vibrant entrepreneurial climate. This is not the case in Europe today.
Least likely: BRICS’ currencies used as a means of international trade
A third and least likely scenario would emerge if one of the BRICS monetary projects materialized and gained traction. To this end, there is currently one vision and two broad ideas on the table.
The vision boils down to considering the dollar a symbol of capitalist oppression and, therefore, hoping that future reliance on the dollar will weaken. In fact, it is an aspiration, rather than a vision.
The first ideas to create a BRICS currency powerhouse is switching from the dollar to the renminbi in trade (past efforts to resort to the Russian ruble as an international means of payment have been shelved). Efforts in this direction have had only limited success, possibly because some countries hesitate to move from capitalist oppression to that of authoritarian policymakers, who also happen to be harsh creditors.
The second idea aims to replace the dollar by making greater use of local currencies. Except for the renminbi and the ruble, however, the record of the BRICS currencies in terms of liquidity and stability is far from stellar. Moreover, the size of BRICS currency-denominated bonds is trivial. In short, the BRICS alternative is not realistic.
This report was originally published here: https://www.gisreportsonline.com/r/dollar-remains-worlds-reserve-currency/
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