CAMBRIDGE – Since 1976, the US dollar’s role as an international currency has been slowly waning. International use of the dollar to hold foreign-exchange reserves, denominate financial transactions, invoice trade, and as a vehicle in currency markets is below its level during the heyday of the Bretton Woods era, from 1945 to 1971. But most people would be surprised by what the most recent numbers show.
There is an abundance of explanations for the downward trend. Since the Vietnam War, US budget deficits, money creation, and current-account deficits have often been high. Presumably as a result, the dollar has lost value relative to other major currencies or in terms of purchasing power. Meanwhile, the US share of global output has declined. And, most recently, the disturbing willingness of some members of the US Congress to pursue a strategy that would cause the Treasury to default on legal obligations has undermined global confidence in the dollar’s privileged status.
Moreover, some emerging-market currencies are joining the club of international currencies for the first time. Indeed, some analysts have suggested that the Chinese renminbi may rival the dollar as the leading international currency by the end of the decade.
But the dollar’s status as an international currency has not fallen uniformly. Interestingly, the periods when the public is most concerned about the issue do not coincide with the periods when the dollar’s share in international transactions is in fact falling.
By the criteria of international use as a reserve currency among central banks and as a vehicle in foreign-exchange markets, the most rapid declines took place from 1978 to 1991 and from 2001 to 2010. Between these two intervals, from 1992 to 2000, there was a clear reversal of the trend, notwithstanding a popular orgy of dollar declinism around the middle of that decade. Central banks held only an estimated 46% of their foreign-exchange reserves in dollars in 1992, but that share rebounded to almost 70% by 2000.
Subsequently, the long-term downward trend resumed. According to one estimate, the dollar’s share in central-banks’ foreign reserves declined from about 70% in 2001 to barely 60% in 2010. During the same decade, its share in the foreign-exchange market also declined: the dollar constituted one side or the other in 90% of foreign-exchange trades in 2001, but only 85% in 2010.
The International Monetary Fund’s most recent statistics suggest, unexpectedly, another pause in the dollar’s long-term decline. According to the IMF, the dollar’s share in foreign-exchange reserves stopped falling in 2010 and has been flat since then. If anything, the share is up slightly thus far in 2013. Similarly, the Bank for International Settlements (BIS) reported in its recent triennial survey that the dollar’s share in the world’s foreign-exchange trades rose from 85% in 2010 to 87% in 2013.
Given dysfunctional US fiscal policy, the dollar’s resilience is surprising. Or maybe we should no longer be surprised. After all, when the global financial crisis erupted in 2008 from the bowels of the American subprime-mortgage market, global investors responded by fleeing to the US, not from it. They obviously still regard US Treasury bills as a safe haven and the dollar as the top international currency, especially given the absence of good alternatives.
In particular, the euro has its own all-too-obvious problems. Indeed, the euro’s share in reserve holdings and foreign-exchange transactions have both declined by several percentage points in the most recent statistics.
At the same time, the IMF’s data indicate that the vaunted renminbi is not yet among the top seven currencies in terms of central-bank reserve holdings. And, according to the BIS, while the renminbi has finally broken into the top ten currencies in foreign-exchange markets, it still accounts for only 2.2% of all transactions, just behind the Mexican peso’s 2.5% share. Despite recent moves by the Chinese government, the renminbi still has a long way to go.
To try to explain the recent stabilization of the dollar’s status, one might note something that the last three years have in common with the previous period of temporary reversal from 1992 to 2000: striking improvements in the US budget deficit. By the end of the 1990’s, the record deficits of the 1980’s had been transformed into record surpluses; today, the federal deficit is less than half its 2010 level.
Perhaps the fiscal observation is a coincidence. After all, it would be foolish to read too much into two historical data points. It would be even more foolish to believe that just because American politicians have failed to dislodge the US dollar from its paramount status over the last 40 years, they could not accomplish the job with another few decades of effort.
It is not an eternal law of nature that the dollar shall always be number one. The pound sterling had the top spot in the nineteenth century, only to be surpassed by the dollar in the first half of the twentieth century. The day may come when the dollar, too, succumbs to a rival. But today is not that day.