Our expert panel explains the U.S. dollar’s current status as the
primary global reserve currency and whether the euro and
renminbi, or even crypto currencies are positioned to take over
that role.
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a unit of account, or a store of value, but generally do not have
legal tender status. Digital assets have no intrinsic value and
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and is therefore more volatile than traditional currencies’
value. Investing in digital assets is risky, and transacting in
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as payment will do so in the future. The volatility and
unpredictability of the price of digital assets may lead to
significant and immediate losses. It may not be possible to
liquidate a digital assets position in a timely manner at a
reasonable price.
Regulation of digital assets continues to develop globally and,
as such, federal, state, or foreign governments may restrict the
use and exchange of any or all digital assets, further
contributing to their volatility. Digital assets stored online
are not insured and do not have the same protections or
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Digital assets can be exchanged for US dollars or other
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Before purchasing, investors should note that risks applicable to
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----- Transcript -----
Michael Zezas: Welcome to Thoughts on the
Market. I’m Michael Zezas, Morgan Stanley's Global Head of Fixed
Income Research.
James Lord: I'm James Lord, Head of FX
Strategy for Emerging Markets.
David Adams: And I'm Dave Adams, head of
G10 FX Strategy.
Michael Zezas: And on this episode of
Thoughts on the Market, we'll discuss whether the US status as
the world's major reserve currency can be challenged, and how.
It's Wednesday, May 8th, at 3pm in London.
Last week, you both joined me to discuss the historic strength of
the US dollar and its impact on the global economy. Today, I'd
like us to dive into one aspect of the dollar's dominance, namely
the fact that the dollar remains the primary global reserve
asset.
James, let's start with the basics. What is a reserve currency
and why should investors care about this?
James Lord: The most simplistic and
straightforward definition of a reserve currency is simply that
central banks around the world hold that currency as part of its
foreign currency reserves. So, the set of reserve currencies in
the world is defined by the revealed preferences of the world's
central banks. They hold around 60 percent of those reserves in
U.S. dollars, with the euro around 20 percent, and the rest
divided up between the British pound, Japanese yen, Swiss franc,
and more recently, the Chinese renminbi.
But the true essence of a global reserve currency is broader than
this, and it really revolves around which currency is most
commonly used for cross border transactions of various kinds
internationally. That could be international trade, and the US
dollar is the most commonly used currency for trade invoicing,
including for commodity prices. It could also be in cross border
lending or in the foreign currency debt issuance that global
companies and emerging market governments issue. These all
involve cross border transactions.
But for me, two of the most powerful indications of a currency's
global status.
One, are third parties using it without the involvement of a home
country? So, when Japan imports commodities from abroad, it
probably pays for it in US dollars and the exporting country
receives US dollars, even though the US is not involved in that
transaction. And secondly, I think, which currency tends to
strengthen when risk aversion rises in the global economy? That
tends to be the US dollar because it remains the highly trusted
asset and investors put a premium on safety.
So why should investors care? Well, which currency would you want
to own when global stock markets start to fall, and the global
economy tends to head into recession? You want to be positioning
in US dollars because that has historically been the exchange
rate reaction to those kinds of events.
Michael Zezas: And so, Dave, what's the
dollar's current status as a reserve currency?
David Adams: The dollar is the most
dominant currency and has been for almost a hundred years. We
looked at a lot of different ways to measure currency dominance
or reserve currency status, and the dollar really does reign
supreme in all of them.
It is the highest share of global FX reserves, as James
mentioned. It is the highest share of usage to invoice global
trade. It's got the highest usage for cross border lending by
banks. And when corporates or foreign governments borrow in
foreign currency, it's usually in dollars. This dominant status
has been pretty stable over recent decades and doesn't really
show any major signs of abating at this point.
Michael Zezas: And the British pound was
the first truly global reserve currency. How and when did it lose
its position?
David Adams: It surprises investors how
quick it really was. It only took about 10 years from 1913 to
1923 for the pound to begin losing its crown to king Dollar. But
of course, such a quick change requires a shock with the enormity
of the First World War.
It's worth remembering that the war fundamentally shifted the US'
role in the global economy, bringing it from a large but regional
second tier financial power to a global financial powerhouse.
Shocks like that are pretty rare. But the lesson I really draw
from this period is that a necessary condition for a currency
like sterling to lose its dominant status is a credible
alternative waiting in the wings.
In the absence of that credible alternative, changes in dominance
are at most gradual and at least minimal.
Michael Zezas: This is helpful background
about the British pound. Now let's talk about potential
challengers to the dollar status as the world's major reserve
currency. The currency most often discussed in this regard is the
Chinese renminbi. James, what's your view on this?
James Lord: It seems unlikely to challenge
the US dollar meaningfully any time soon. To do so, we think
China would need to relax control of its currency and open the
capital account. It doesn't seem likely that Beijing will want to
do this any time soon. And global investors remain concerned
about the outlook for the Chinese economy, and so are probably
unwilling to hold substantial amounts of RNB denominated assets.
China may make some progress in denominating more of its
bilateral trade in US dollars, but the impact that that has on
global metrics of currency dominance is likely to be incremental.
David Adams: It’s an interesting point,
James, because when we talk to investors, there does seem to be
an increasing concern about the end of dollar dominance driven by
both a perceived unsustainable fiscal outlook and concerns about
sanctions overreach.
Mike, what do you think about these in the context of dollar
dominance?
Michael Zezas: So, I understand the
concern, but for the foreseeable future, there's not much to it.
Depending on the election outcome in the US, there's some fiscal
expansion on the table, but it's not egregious in our view, and
unless we think the Fed can't fight inflation -- and our
economists definitely think they can -- then it's hard to see a
channel toward the dollar becoming an unstable currency, which I
believe is what you're saying is one of the very important things
here.
But James, in your view, are there alternatives to the US led
financial system?
James Lord: At present, no, not really. I
think, as I mentioned in last week's episode, few economies and
markets can really match the liquidity and the safety that the US
financial system offers. The Eurozone is a possible contender,
but that region offers a suboptimal currency union, given the
lack of common fiscal policy; and its capital markets there are
just simply not deep enough.
Michael Zezas: And Dave, could
cryptocurrency serve as an alternative reserve currency?
David Adams: It's a question we get from
time to time. I think a challenge crypto faces as an alternative
dominant currency is its store of value function. One of the key
functions of a dominant currency is its use for cross border
transactions. It greases the wheels of foreign trade. Stability
and value is important here. Now, usually when we talk to
investors about value stability, they think in terms of downside.
What's the risk I lose money holding this asset?
But when we think about currencies and trade, asset appreciation
is important too. If I'm holding a crypto coin that rises, say,
10 per cent a month, I'm less likely to use that for trade and
instead just hoard it in my wallet to benefit from its price
appreciation. Now, reasonable people can disagree about whether
cryptocurrencies are going to appreciate or depreciate, but I'd
argue that the best outcome for a dominant currency is neither.
Stability and value that allows it to function as a medium of
exchange rather than as an asset.
Michael Zezas: So, James, Dave, bottom
line, king dollar doesn't really have any challengers.
James Lord: Yeah, that pretty much sums it
up.
Michael Zezas: Well, both of you, thanks
for taking the time to talk.
David Adams: Thanks much for having us.
James Lord: Yeah, great speaking with you,
Mike.
Michael Zezas: And as a reminder, if you
enjoy Thoughts on the Market, please take a moment to rate and
review us wherever you listen to podcasts and share Thoughts on
the Market with a friend or colleague today.
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