Will the Dollar Remain the Global Reserve Currency?
De-dollarisation has become a trending geopolitical topic after the perceived weaponisation of the greenback as a tool to sanction Russia for its invasion of Ukraine. Portfolio manager Rashaad Tayob suggests that the threat of de-dollarisation is an underappreciated risk, given the speed at which geopolitical shifts are materialising.
The US dollar has been the de facto global reserve currency since the middle of the last century. Before then, the United Kingdom’s pound sterling dominated global reserves from the early 19th century. However, sterling fell from favour after the UK nearly bankrupted itself during the first and second world wars. Today the US dollar accounts for almost 60% of global central bank foreign-currency reserves, while pound sterling is less than 5%.
Other currencies have also occupied dominant status in history, including those from Portugal, Spain, the Netherlands and France from the Renaissance onwards. The lesson here is that dominant reserve currencies do change from time to time — and do so swiftly. But hope for swift de-dollarisation may be premature thinking.
Aside from its global central bank reserve status, the US dollar accounts for about 90% of the foreign exchange — or FX — market. Neither the euro nor the Chinese renminbi has been able to make significant inroads over the last three decades. For all intents and purposes, the FX market is the dollar market. Despite China being the largest trading partner for much of the world, global trade is still conducted primarily in US dollars.
The recent freezing of Russian central bank US dollar reserves was a watershed moment and a wake-up call to countries not aligned with the US. This weaponisation of the dollar, combined with recent high inflation and reckless US fiscal spending, has provided renewed impetus to the push for de-dollarisation. The US has benefited from the dollar being the global reserve currency for the last 70 years. Recent events created concerns that it may be abusing its ‘exorbitant privilege’ (see Did You Know?).
The BRICS group of countries — Brazil, Russia, India, China and South Africa — has proved to be the ideal platform through which China and Russia could drive the de-dollarisation agenda. The recent addition of six new member countries — including oil heavyweights Saudi Arabia, UAE and Iran — was a big win for the BRICS (there are reports that other nations are lining up to join). The 11-member grouping now represents a major bloc of energy producers, 45% of global GDP and 50% of the world’s population.
In my view, it is too early to announce the end of the petrodollar system, given that the currencies of the UAE and Saudi Arabia are still pegged to the US dollar — they are effectively dollarised. It nevertheless suggests a desire to pivot from the existing system and be less dependent on the US and its currency. For example, the currencies of the UAE and Saudi Arabia also suffered effective devaluations from US dollar printing and reckless spending during the COVID-19 pandemic. Their own large holdings of US Treasuries and other assets are at risk if they suffer Russia’s plight by ever incurring US sanctions.
The economic impact of de-dollarisation would be felt in the US in terms of the value of the dollar and potentially in US interest rates. As the issuer of the global reserve currency, the US has never had to worry about its persistent trade deficits as it pays for its imports in the currency it controls and prints — the ‘exorbitant privilege’ of owning the global reserve currency.
US trade deficits have been consistently recycled into US bond and equity markets: countries like China, which are net sellers to the US, place those dollars back into the US financial system in the form of central bank reserves, or by investing in US Treasuries. Since 2008, the US has run with ultra-low interest rates as well as massive amounts of money printing — without affecting the dollar’s value. However, should the US be forced to run a more balanced trade position, the dollar would need to weaken. Its ability to inflate its way out of its sovereign debt problems may also diminish if global reserve holdings of US dollars are reduced.
What are the alternatives? And what of the proposal of a BRICS currency? As the idea of a BRICS currency gets fleshed out, it seems increasingly clear that the potential exists for the currency to work, but only if it is backed by gold. Russia and China have accumulated large gold reserves since 2010 and have accelerated their purchases in recent years. Gold was effectively the global reserve currency from the time the Bank of England adopted the gold standard in 1821 until the US terminated convertibility of the US dollar to gold in 1971 (Britain left the gold standard in 1931). No countries still use the gold standard today and its role in the financial system has been greatly diminished.
We have been positive on gold bullion and hold it in our portfolios as it has proven to be a reliable store of value and a hedge against geopolitical and systemic risks. We viewed the remonetisation of gold as a small-probability event, but one with a potentially massive effect on the gold price. Should gold be allowed back into the financial and banking system through the BRICS currency, it would provide an alternative to fiat currencies (government-issued currencies not backed by commodities such as gold). There is a strong probability that it would take a meaningful share of global savings, reserves and trade.
Having gold as an alternative available currency would also limit the ability of other countries to run zero — or negative — interest rates and devalue their currencies through money printing, because global savers would instead quickly convert savings to gold-backed currencies. There are many hurdles to the remonetisation and rebanking of gold, but it is one that has moved from a small probability to one that is foreseeable — and even to one that is being planned for. It further cements our view that gold has an important part to play in multi-asset portfolios.