Market Overview

Lately markets have been buzzing with constant speculations about the fundamentals of the U.S. Dollar as a reserve currency and about a possible crash of the Dollar-pegged system that is poised to be dismantled. For whatever reason, the question currently in the air is whether the Greenback has to lose its role as the world’s number one currency and step back from the international arena in favour of other currencies. The short answer is very simply no. But what are the reasons behind these speculations, and what are the most possible yet distant perspectives for the American currency?

First, the Default. This reason is largely debated as the U.S. debt nears its ceiling. This year the government debt ceiling is at $31.4 trillion, and Congress has to raise it further to avoid the default. The U.S. is claimed as the country that has not defaulted in its history. But is it true? Yes. But to a certain extent. The French government led by a World War II prominent ‘The General’ Charles de Gaulle, who took over Nazi Germany and founded the Fifth Republic, has send French reserves in U.S. Dollars to be exchanged into gold at the official rate in February 1965 as the Dollar was pegged to gold. After this successful operation several countries followed and draining the U.S. gold stock. This resulted in the end of the gold peg of the Dollar and the end of the Bretton Wood System that was based on the convertibility of the U.S. Dollar into gold. President Richard Nixon in 1971 undertook a series of measures to stabilise the American economy that was suffering from surging inflation and cheap imports that, among other results, cancelled this convertibility. Although it was meant to be a temporary measure, later it became permanent de-facto which dismounted the Bretton Wood System, as this convertibility was its major cornerstone.

So, informally the United States has already defaulted as it refused to follow its obligations. The new global monetary system was created in Jamaica in 1973, along with fiat currencies and the Forex market as we know it in principle.

Even as this is the case, there was no crash of the Dollar. The Greenback is still dominating the world. Many countries, including Japan and China, are largely exposed to the U.S. debt. So, any major financial issues do not resonate with their interests. Moreover, they are likely to undertake everything that is needed to support the Dollar, to a certain extent, of course.

Second, the rise of the role of alternative currencies in international trade and reserves. Some countries chose national currencies as the better vehicle for trade settlements. The brightest example is the Euro that emerged at the Eve of the XX century. The Euro took a major part in the international settlement and its role is continuously rising. The single currency is now responsible for 36% of global transactions, 16% of the world’s trade, and 21% of international reserves. Following the same sequence, the U.S. Dollar possesses 42%, 40% and 60% respectively. But, even a strong currency like the Euro, which is backed by a significant number of developed nations, like Germany and France, has not removed the Dollar as the world’s number one currency. It would be naïve to assume that the Chinese Yuan, with its 2% of the total international transactions and 3% in global reserves, could replace the Dollar in the foreseeable future. Neither could other local currencies as most of such national currencies are extremely vulnerable to national regulations, which are mostly inappropriate for reserve currencies and to political risks. The Dollar is mostly free of these issues and it is still globally accepted without any limitations. International trade plays an immense role in this regard, as most of the transactions are made in reserve currencies. Export-centered countries like China, Gulf nations, Brazil, and even European countries with their huge exports, would lose indisputably much more if the Dollar does crash. China, for example, had a positive trade balance of $88.2 billion in March 2023. That meant that the country sells more than it imports, and it brings in more money from outside than money it gives out. If China’s trading partners have to pay in Yuan, they have to take this money from somewhere. There are simply not enough Yuans out there. On the other hand, China has not got enough goods and services to offer in exchange for Yuan as the trade balance is positive. A simple answer to the dilemma would be to print more Yuans. But who will need them? India, Saudi Arabia, Turkey, or maybe Brazil? But these countries could not exchange this large amount of Yuans elsewhere outside of China. It simply doesn’t make sense on the global scale. Thus, the role of the Yuan will be rising, but gradually. And it certainly could not remove the Dollar from its leading role, at least as long as China has a positive trade balance, and while the U.S. has the ability to support the Dollar in this position.

Third, any kind of a devastating financial crisis in the United States. These fears have intensified after a recent banking turmoil and rising recession fears. America has seen many financial crisis , including the recent Global Financial Crisis in 2008-2009, when the Greenback lost 40% to the basket of major currencies compared to 2002. The U.S. Dollar index was at 89 points, 11% below current levels at 101 points. Was it a crash for a Greenback? Certainly not. Even during an expected contraction of the American economy in 2024 and declining interest rates, the Dollar is to remain a “gold standard” in international settlements.

To resume, the role of the Greenback will decline gradually, very slowly, and without any major economic shocks. Regional alternative currencies may develop and become stronger as some nations are strongly opposed to American dominance and its international rulemaking. But for the time being the U.S. Dollar is very comfortable and easy to handle as it is accepted worldwide without any major hurdles. It is a universal currency, cheap and reliable, safe for investing and as a reserve currency. Nothing personal, just business. A crash that has the power to replace the Dollar has yet to come.

Disclaimer:

Analysis and opinions provided herein are intended solely for informational and educational purposes and don't represent a recommendation or investment advice by TeleTrade.