Is the Dollar’s Global Status at Risk?
MODERNIST’S ASSET CLASS INVESTING PORTFOLIOS ARE STRATEGICALLY INVESTED WITH A FOCUS ON LONG-TERM PERFORMANCE OBJECTIVES. PORTFOLIO ALLOCATIONS AND INVESTMENTS ARE NOT ADJUSTED IN RESPONSE TO MARKET NEWS OR ECONOMIC EVENTS; HOWEVER, OUR INVESTMENT COMMITTEE EVALUATES AND REPORTS ON MARKET AND ECONOMIC CONDITIONS TO PROVIDE OUR INVESTORS WITH PERSPECTIVE AND TO PUT PORTFOLIO PERFORMANCE IN PROPER CONTEXT.
Our Investment Committee has seen an increase in questions about the future status of the U.S. dollar as the world’s reserve currency. ‘World’s reserve currency’ simply means that it’s the most widely used currency in global trade and finance. As one example, the U.S. dollar dominates foreign exchange transactions, estimated to be involved in approximately 90% of all currency trades as of 2022. (1) This, among many other data points, illustrates that the dollar is currently the only currency with serious claim to the reserve currency title. That said, recent news about China’s yuan, also known as the renminbi, has led to some speculation: Is the dollar at risk of losing its status? And what might be the implications?
Is the U.S. dollar at risk of losing its reserve currency status?
In our opinion, the legitimate concerns facing the U.S. dollar’s reserve currency status are:
The massive growth in U.S. federal government debt relative to the size of the U.S. economy.
Substantial national deficits year after year, with no end in sight.
Continued challenges connected to China.
The advantages the U.S. possesses relative to other countries are the sheer size and dynamic nature of its economy and a foundational respect for property rights and the rule of law. While there are other countries that could claim to possess one of these two strengths — or even claim superiority to the U.S. in one of the two areas — there is, in our opinion, no country (or bloc of countries) that credibly challenges the U.S. on both counts. One could argue that the closest challenger is the bloc of countries that use the euro. However, there is simply no evidence of a pronounced increase in the use of the euro in global trade and finance relative to the dollar. As for the use of China’s yuan in global trade and finance, it barely registers when compared with either the dollar or euro.
What might be the implications for investors?
Our best guess is that if the dollar were to lose reserve currency status over the longer term, the impact on global markets would be slight. Although the dollar would depreciate relative to other currencies, there is no reason to assume that losing its status alone would have a catastrophic impact on global stock and bond markets. Within the last two centuries, global money has transitioned from gold to irredeemable fiat currencies to U.S. dollars redeemable for gold and to irredeemable U.S. dollars. Meanwhile, global stock markets have generally trended up. In other words, the last two centuries have certainly seen currency upheaval.
What should investors do if they are still worried?
Although an abrupt change in the dominant currency used could lead to market turmoil, a gradual change would be unlikely to disrupt markets. We continue to believe that the most effective protection against this risk — and all others — is broad, global diversification; a relatively short maturity bond portfolio of high-quality nominal and inflation-protected bonds alongside globally allocated, low-management-cost stock holdings.
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1 Source: J.P. Morgan, Michael Cembalest. Eye On The Market. April 26, 2023.
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