Is the Reign of the U.S. Dollar Coming to an End?: Assessing the Future of Global Reserves

Tariffs notwithstanding, the United States has fiscally been in such a tumult in recent years. Last month, the credit rating agency Moody's downgraded the United States from Aaa to Aa1. This downgrading is significant for two reasons. One is that the United States is the largest economy in the world. The second reason is that Moody's is the final major credit rating agency to downgrade the United States below its top credit rating. Much like with Fitch's downgrade in 2023, Moody's cited long-term debt issues fueled by the mandatory spending. Moody's anticipates that the United States' fiscal performance is to deteriorate at a faster rate relative to other highly-rated sovereigns. 

This got me thinking about a major topic related to all this mess. The United States dollar (USD) is the most held currency in global reserves. However, that clout has been declining over the years (see above). International Monetary Fund (IMF) data show that at the end of 2024, 58 percent of foreign exchange reserves are USD. Contrast that with the dollar being 65 percent a decade earlier. How legitimate is the concern that the percent of dollars in foreign reserves will continue to decline over time?  We should first ask what could replace the dollar as the primary global reserve. 

• Chinese yuan (人民币). China has the second largest economy and is continuing to grow, hence why it is a main contender. However, as long the Chinese central bank (中国人民银行) has exchange rate regime (currency manipulation), capital controls, and institutional weakness, the Chinese yuan will not be a global currency reserve. 
• The euro. The European Union rivals that of the United States and has political stability. However, it has internal economic issues that I have critiqued since 2010 and have done so since then (see here, here, and here). It is not only the lack of a common treasury or a unified European bond market, not to mention that its capital markets are inadequately integrated to muster the assets necessary to become a global leader. As a research paper from the European Commission points out, the euro zone crisis last decade resulted in the downgrade the credit rating of various European countries, thereby strengthening the dollar (Arroyo, 2022). 
• Other currencies. The Japanese yen, Korean won, Australian dollar, Canadian dollar, and British pound lack the scale and liquidity to pull it off. The BRICS countries cannot cobble together a currency basket to rival the U.S. economy because of the structural challenges that do not make their countries' central banks robust. 
• Digital and blockchain alternatives. This option could have potential in the future. However, given current regulatory hurdles and the fact that these alternatives are still relatively nascent, they are not viable options, certainly in the short-term.

There is still no viable contender to step in and replace the U.S. dollar in the short-term. The United States remains a large, powerful economy that accounts for 26 percent of the world's GDP with rule of law and investor confidence. Because it takes a lot of time, money, effort, and political willpower to change currencies, there is inertia vis-à-vis the network effects that are in the U.S.' favor. The U.S.' market for Treasury securities remains large and liquid. The dollar is still the dominant currency choice for international trade transactions because the dollar is so entrenched in global trade and finance. That being said, it is clear from the Moody's downgrading that the U.S.' fiscal situation is untenable and it is looking like there is a lack of political will to change things. 

In July 2024, the CFA Institute surveyed nearly 4,000 global financial professionals. Not only did 77 percent of respondents find that the U.S.' finances are unsustainable, but nearly two thirds had the professional opinion that the U.S. will lose its global reserve status (52 percent in a marginal way and 11 percent in a material way). It was also interesting to see the reasons that respondents thought this would happen. Debt was number one, followed by a downright default (see below).

What does this mean for the global reserves system? Going back to the CFA Institute survey, what the respondents believed to be the most likely systems to replace the dollar would be a multipolar currency system, a digital currency, and hard currency (e.g., gold). If I were to speculate, I would say the system is becoming more multipolar and there will be an emergence of digital currency in global reserves. I believe that the dollar's prominence will remain in the short term but also decline gradually, much like it has in the past couple of decades. The fiscal cliff is not imminent, but it is the direction in which the United States is heading.

What came as a result of the COVID pandemic and the lockdowns has taught me to be more humble with my educated guesses, especially when prognosticating beyond a year or so. What I can say with certainty is that that more the United States government avoids meaningful fiscal reform and adds on deficit spending, the more that dollar will lose its dominance. The question simply will be a matter of how much dominance is lost, what will take its place, and how ugly of a process it will be.