Will the US Dollar be replaced as the world’s reserve currency?

Towards the end of Q2 in 2020, Bloomberg reported that Goldman Sachs Group Inc spotlighted that there was a growing concern regarding inflation in the U.S, issuing a warning that the dollar was in danger of losing its crown as the world’s reserve currency.  JPMorgan echoed this same concern, observing that the euro has been viewed as an increasingly favourable substitute, publishing that ‘US economic outperformance relative to the euro area and Japan (no longer) seems guaranteed, at least over the next few years, given the faltering virus response’ (International Banker). At the end of 2020, Karen Young wrote in China Macro Economy that ‘in October, the US dollar lost its status as the world’s most used global payments currency. It was the first time the US dollar has fallen behind the euro since August 2013. 

Vorto’s Bobby Ward explores whether the US dollar is under threat and will be replaced the world’s reserve currency:

Since its peak in March 2020, the US dollar has weakened by 13 per cent against a basket of major currencies (China Macro Economy).  This decline was fuelled by an inflating current account deficit as a response to Covid-19 as well as concerns regarding expansionary US fiscal and monetary policies. Such a decline to the US dollar has raised questions regarding the currency’s status for pre-eminent reserve currency and being a leading force in global payments. Observers have been speculating as to whether the changes in the global economy, including currencies, the growth of China’s economic rise and U.S sanctions will see the US dollar lose its place as the world’s reserve currency (CRS reports). Amidst a client of geopolitics and near-zero US interest rates, both investors and countries have been conjuring up ways to look for alternatives. 

So what are the potential alternatives? 
 
China’s yuan has been one potential alternative that observers and investors have been exploring. A report by Morgan Stanley has predicted that due to increasing foreign investment, the yuan could grow from currently representing approximately 2 percent of global foreign-exchange reserve assets to 5 to 10 percent by 2030. Such a prediction would mean that the yuan would surpass the yen and the British pound to become the third-largest reserve currency in the world, behind the euro. However, whilst this prediction shows the yuan’s growth and strength, it is also worth noting that the yuan’s use in global economic activity is weak in comparison to the US dollar.  (International Banker). In reference to the Bank for International Settlements (BIS), the US dollar accounted for 88% of all foreign-exchange transactions in 2019, illustrating the currency’s supremacy on a global stage. At the same time, despite China’s rise to growth and speculation that the yuan could replace the dollar, it is worth considering that China maintains strong capital controls over currency that flows in and out of the country. This therefore hinders the efficiency of liquid markets functioning, which should be accessible to the rest of the world. 
 
Whilst the yuan is one speculation that observers are considering in lieu of the US dollar as the world’s reserve currency, another option are digital currencies. Over the last decade, there has been a race to create widespread digital currencies. Amongst the private sector, thousands of cryptocurrencies have been developed (CRS reports). By definition, a cryptocurrency is a digital asset designed to work as a medium of exchange using a distributed ledger technology and has no status of legal tender. In reference to a 2020 BIS survey, approximately 80% of central banks are working on developing digital currencies, illustrating their potential. Unlike privately issued digital currencies, central bank developed digital currencies would serve as legal tender. Coinbase Cofounder/CEO Brian Armstrong, believes that digital currencies and bitcoin in particular have the potential to replace the US dollar as the world’s reserve currency, predicting that digital currency could supplant the greenback by 2030. Sharing this view, Chief global strategist of Emerging Markets at Morgan Stanley Investment Management published an opinion piece in the Financial Times explaining how bitcoin is taking steps towards becoming the world’s reserve currency. He argued that bitcoin is achieving mainstream acceptance, stating that ‘whilst the currency is held as an investment today, this is changing. Governments should not assume that traditional currencies are the only stores of value or mediums of exchange’. To illustrate his point, he explains that financial giant Paypal is planning to allow 28 million merchants accept bitcoin in its subsidiary Venmo in 2021. However, whilst there are supporters for digital currencies, FXCM explains that in order for this to happen, digital currencies would need to make progress in several important areas, including its intense volatility. 
 
Whilst there are both skeptics for China’s yuan and the rise of digital currencies, there is also increasing concern for the long-term health of the dollar and whether it will serve to remain as the world’s reserve currency. The future could see bitcoin gain momentum and become mainstream, replacing the US dollar, or perhaps China’s yuan will achieve this feat and establish itself as the third-largest reserve currency in the world.