During periods of heightened global risk, investors’ willingness to take risk declines, leading them to move capital toward the US dollar.
As a result, the dollar appreciates, making it important to examine how global risk shocks influence international adjustment. Evidence suggests that a stronger dollar significantly amplifies the negative effects of these shocks.
For example, the Federal Reserve’s liquidity injections during the COVID-19 crisis helped stabilize global economic activity by easing pressure on the currency.
The United States and the dollar play a central role in global trade and financial flows, and this dominance becomes more visible during times of uncertainty.
The correlation between the dollar and global risk can be explained by the relative safety and liquidity of certain US assets. However, an important question remains: does dollar appreciation help cushion global shocks or worsen their impact on the world economy?
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The Present Of Dollar Dominance
Sanctions against Russia have reawakened an old fear: the weaponization of the dollar would put an end to the dollar’s status as the world’s reserve currency. Foreign nations, the reasoning says, would not use this currency if the dollar could be used against them. It’s a no-brainer for China, the world’s biggest economy, to establish the yuan as a competing reserve currency.
The dollar’s share of central banks’ foreign-exchange reserves has declined from about 65% to around 60% since 2008. The next largest reserve-currency issuers are the European Union (21%), Japan (6%), and the United Kingdom (5%). If further US financial sanctions were imposed on China, these regions would likely support them, partly due to geopolitical alignment and partly because European and Japanese institutions seek to avoid exclusion from the US financial system.
In response to potential US sanctions, several countries have accelerated efforts to reduce their dependence on the dollar. Russia has been among the most active, shifting a significant portion of its foreign-exchange reserves away from the US dollar into other currencies. The country’s sovereign wealth funds have also committed to reducing dollar holdings.
Central banks use dollars for the same network-driven reasons that businesses and individuals do. Just as people learn English because it is widely used, institutions hold dollars because others do the same. Globally, about three-quarters of private foreign-currency bank deposits are denominated in dollars, and a large share of corporate foreign-currency borrowing also relies on the dollar. Neither trend shows significant decline, and according to the Federal Reserve, roughly half of all US dollar banknotes are held outside the United States.
Dollar Supremacy – Will It Continue?
Despite Goldman Sachs Group and Credit Suisse Group’s recent warning that the dollar’s dominance is in danger, finding a viable successor will be exceedingly difficult, according to funds from JPMorgan Asset Management to Brandywine Global Investment Management. To this day, treasuries remain a safe haven for investors looking to park their money, and the dollar benefits greatly from haven flows because of its immense size and strength.
Mark Mobius, a veteran investor and founder of Mobius Capital Partners, argues that there are currently no viable alternatives to the dollar. He notes that the dollar remains strong and could strengthen further if global tensions continue to rise.
Despite earlier predictions that the dollar’s role would weaken after the 2008 financial crisis, the Federal Reserve took on a more global role in stabilizing financial markets, reinforcing the currency’s position. According to data from the Bank for International Settlements, more than 90% of transactions in the $6.6 trillion daily foreign-exchange market involve the US dollar.
Although the International Monetary Fund has attempted to gradually reduce dollar dependence, the currency still represents about 60% of central bank foreign-exchange reserves, while the euro accounts for roughly 20%.
Agnes Belaisch, chief European strategist at Baring Investment Services, noted that while the Central Bank of Russia has reduced dollar holdings and increased gold reserves, recent events suggest those efforts may have limited practical impact. Non-dollar reserves still rely on counterparties for conversion into usable payment currencies, and large-scale payments cannot realistically be made using gold or cryptocurrencies. In most global transactions, dollars remain essential at both the beginning and the end of the payment chain.
Even so, countries such as China continue efforts to internationalize the yuan as an alternative to the dollar system. Speaking before the United States Senate Banking Committee, Jerome Powell said the situation in Ukraine may accelerate the development of alternative payment systems outside dollar-dominated networks. Analysts at Morgan Stanley project that the yuan could surpass the yen and sterling to become the world’s third-largest reserve currency by 2030, potentially reaching up to 10% of global foreign-exchange assets over the next decade.
FAQ Section
1. Is the US dollar losing its dominance?
The dollar’s share of global reserves has slightly declined over the years, but it continues to be the primary currency for trade, reserves, and financial transactions worldwide.
2. Why do investors still trust the dollar?
Investors view US financial markets as liquid, stable, and secure. During global uncertainty, money often flows into dollar-denominated assets as a safe haven.
3. Which currencies could challenge the dollar?
The euro and Chinese yuan are the main alternatives, but neither currently matches the dollar’s global liquidity, trust, or financial ecosystem.
4. What is de-dollarization?
De-dollarization refers to efforts by countries to reduce reliance on the US dollar in trade, reserves, and payment systems by using alternative currencies.
5. Can the dollar be replaced soon?
Most analysts agree that a sudden replacement is unlikely. Any shift away from the dollar would likely be gradual and take place over many years.
6. Why does the dollar strengthen during crises?
Because it is widely seen as a safe and liquid asset, investors tend to move into dollars when global risk rises, which increases demand and strengthens the currency.