The dollar has weakened. Here’s why that actually entrenches its role as the world’s reserve currency
By Steve Goldstein
The U.S. dollar is still on top.(Getty Images)
It doesn’t make much sense for the dollar to be as widely used as it is. Sure, the U.S. economy is the largest in the world, but the dollar is on one side of 88% of all currency trades, despite the U.S. accounting for roughly a quarter of global gross domestic product. Countries, most notably China and Russia, also are upset the U.S. is able to wield its currency dominance to sanction government officials across the world.
But even as the dollar has fallen 8.5% from the highs of March, according to the WSJ dollar index (XX:BUXX), there is still no clear path or even idea on how to replace the dollar’s role in the global financial system. It was only a year ago that former Bank of England Gov. Mark Carney suggested Facebook’s Libra cryptocurrency could be a replacement, an idea that now sounds ludicrous given the project’s struggles, even as Carney’s critique over dollar hegemony proved apt when there was a dollar shortage during the beginning of the coronavirus pandemic.
Brad Setser, senior fellow at the Council on Foreign Relations, makes another point.
“A weaker dollar tends to lead to more intervention by countries looking to protect their exports in the foreign exchange market, and thus more reserve accumulation,” he says in a blog post this week. “A weaker dollar thus typically results in higher not lower demand for dollars from the world’s reserve managers.”
And how do these reserve managers accumulate dollars? By buying U.S. Treasurys, which comes in handy as the U.S. is issuing debt at a rapid rate, as the latest budget deficit numbers released on Wednesday reinforce.
Setser says a number of countries have been back in the market in June and July actively working to depreciate their currency — singling out Thailand, Taiwan, Singapore and India in particular.
“Many export-based economies with large external surpluses are willing to let their currency fall against the dollar, but they remain reluctant to let their currency appreciate against the dollar when the tide turns. And thus the bulk of the world’s accumulation of dollar reserves has tended to come when the market is pushing the dollar down not up,” he writes.
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