The IMF’s latest survey of official foreign exchange reserves shows that the share of US Dollar reserves held by central banks fell to 55 per cent during the 1st quarter of 2021 — its lowest level in 25 years.
According to the IMF, this partly reflects the declining role of the US dollar in the global economy in the face of competition from other currencies used by central banks for international transactions.
Below are some currencies that are predicted to give the dollar a run for its money:
The Euro is already the world’s second-biggest reserve currency with roughly €2.5 trillion ($2.94 trillion) in central banks globally.
The euro presents itself as an alternative reserve currency because of several advantages:
- Despite economic mismanagement by a few member states like Greece and Spain, the Eurozone is, by and large, made up of healthy, well-regulated economies with a total GDP of $15.6 trillion placing it slightly higher than China
- The European Central Bank (ECB) is credited as being generally governed in a steady and fairly predictable manner. It successfully navigated a dangerous crisis in 2010 managing to pull together a bailout package and ward off the Euro’s dissolution
On the other hand, there exists barriers that can also play against the Euro growing its share of global reserves:
- Since the governing council of the ECB is composed of a six-member executive board and the governors of all 19 Eurozone central banks, major conflicts between member states on monetary policy could lead to governance gridlock or breakdown which creates risk relative to the more unitary U.S. Fed
- Each member state of the Eurozone issues its Euro bonds which do not mirror the strengths and weaknesses of the Eurozone as a whole. This adds to the complexity of using them as reserves
After the Euro, the Japanese Yen is the most widely held reserve at $692.10 dollars in Q1 2021.
However, with most Japanese debt being held domestically, the available supply of Yen-denominated reserve is limited. Being a net exporter, it may simply not have enough international debts for its bonds to serve as global reserves.
One reason for the USD’s status as a dominant reserve currency is because Americans can’t seem to live within their means.
After the Japanese Yen, China’s Yuan is the most held currency in the world, at $287.46 billion in Q1 2021.
In the last 5 quarters, this value has steadily increased from $220.33 billion in Q1 2020.
China has been trying to make its currency appealing as a global reserve and trading instrument for at least a decade. This is also aided by its growing economic size and global political influence.
However, several obstacles stand in the Yuan’s way:
- A global lack of faith in Chinese political stability and rule of law which was highlighted recently by a sudden, broad crackdown on financial technology by the ruling Chinese Communist Party
- Such interventions and collapses cast doubt on China’s commitment to free markets, its regulatory rigor and, in turn, the fundamental strength of the Chinese economy
- Tight control over its currency has been a major pillar of its long rise as an economic power, however, this is incompatible with global reserve status
- Tight controls on the flow of capital out of China because the Communist Party wants domestic capital to be invested within China is in contradiction with reserve currency status since such a currency would have to be freely tradeable
Many bitcoin advocates, such as Nick Szabo, a crypto pioneer, point to unsustainable global debt levels and argues that defaults on sovereign bonds will become widespread this century.
In this scenario, bitcoin reserves would become a kind of backstop, a ‘hard’ asset that would still be standing in the case of a wave of bond defaults and central banks would turn to them.
As a ‘trustless’ currency, bitcoin presents a neutral medium of international exchange making it possible for countries to trade without enhancing America’s geopolitical leverage by relying on it to move value.
Moreover, countries facing conflict are also being predicted to hold bitcoin. Still bitcoin’s adoption as reserve currency has significant obstacles to overcome:
- Bitcoin’s main disadvantage is its price instability, with daily percentage swings still regularly in the double digits
- Bitcoin would be unappealing for official use in nations that already have their own nominally healthy currency, because it would limit their power to control their money supply
So, in the last analysis, what’s the dollar’s biggest rival?
Short answer; the Euro.
It’s already a strong second place to the dollar and built on a legacy of relatively responsible banking. European political integration, though slow, is ongoing, and the ECB could easily issue more Eurozone bonds.
Cryptocurrencies like bitcoin however remain the greatest unknown of all.
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