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Manpreet Gill, Chief Investment Officer of Africa, Middle East and Europe
The US Dollar has held a pre-eminent place in the world’s economy since the end of World War II. Its wide acceptance has meant it comprised the lion’s share of global reserves and settlement of trade and served as a global benchmark for many countries to peg their currencies. According to the Bank for International Settlements, the US Dollar remains the single-most traded currency in the FX market, with nearly 90% of FX transactions involving the greenback in some way.
There have always been questions about how long the US Dollar would be able to retain this special status. There have been many attempts to find replacements over the past 75 years, especially as the non-US share of the world economy has grown. Is the world really ready for ‘de-Dollarisation’?
To answer this question, we would need to get more specific about what ‘de-dollarisation’ really means. The US Dollar arguably holds two key roles in the global financial system in this context. The first is its role as a reserve currency for global central banks. The second is its role in settlement of global trade flows.
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Dollar still a key reserve currency
Several arguments have been made about what central bankers look for when considering allocating to non-US Dollar currencies: (i) the presence of open capital account, (ii) greater ease and lower cost of trading non-USD currencies, (iii) track record of economic and policy stability, (iv) the presence of US Dollar swap lines, which should raise confidence in the currencies, (v) opportunity to diversify away from the US Dollar into currencies that offer higher returns and lower volatility and (vi) geopolitical objectives.
When placed against this context, it is easier to explain some of the changes we’ve witnessed in global reserves in recent decades. The US Dollar remains the largest global reserve currencies; it comprises just under 60% of global foreign exchange reserves. The Euro has arguably had the most success as an alternative reserve currency and now comprises just over 20% of global reserves. More recently, an IMF study noted that much of the shift away from the US Dollar in recent years was driven by formerly less popular currencies such as the Australian Dollar, Canadian Dollar, Swedish Krona and South Korean Won. The share of the Chinese Renminbi also rose.
As the IMF put it, the US Dollar’s share of global foreign exchange reserves continues to extend what has been a two-decade decline, but it is still used more than all other currencies combined.
Other currencies make progress in trade settlement
When it comes to settlement of global trade, non-US Dollar currencies form a rising share. The Bank for International Settlements noted that the US Dollar’s share in trade invoicing and payments ranges from about 40-50%, smaller than its share in global reserves but much larger than its share of global trade. Having said that, regional variations around this broad average can be large. SWIFT data shows the bulk of global trade (over 75%) was cleared in US Dollars and Euros, despite other countries forming a significant share of global trade.
Factors cited for a currency’s use as a trade settlement currency are similar to those for a reserve currency. The one additional factor important in a trade settlement context is how the currency used can be ‘recycled’ i.e., if a country’s exports are settled in a certain currency, can that currency be subsequently used to either purchase imports, or be deployed in global investments?
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Investor implications – gold could be a surprise winner
In recent months, we have seen an escalation in efforts to create alternatives to the US Dollar. Much of these efforts are focused on trade settlement. For instance, at a multi-lateral level, there have been calls for the creation of a BRICS currency. Countries are also making increased efforts to develop mechanisms for settling bilateral trade in local currencies.
For investors, though, we believe any such shift will be gradual. As data on the US Dollar’s share in both global reserves and trade settlement shows, any changes tend to be slow, running through decades. This arguably makes sense given the factors that drive the development of reserve currencies.
Gold, of course, could be a somewhat unexpected beneficiary of the US Dollar’s long-term decline. The precious metal offers central bankers one immediate source of diversification out of the US Dollar. This is an option global central banks already appear to be exercising, given the sharp rise in central bank gold purchases since early 2022. While we do not see gold as a significant alternative to the US Dollar – there simply isn’t enough gold available for it to become the dominant reserve asset – central bank purchases are likely to impose a floor on prices, especially if other factors like falling real bond yields and safe haven demand offer support.
Disclaimer
This article is for general information only and it does not constitute an offer, recommendation or solicitation of an offer to enter into any transaction or adopt any hedging, trading or investment strategy, in relation to any securities or other financial instruments. This article has not been prepared for any particular person or class of persons and does not constitute and should not be construed as investment advice or an investment recommendation. It has been prepared without regard to the specific investment objectives, financial situation or particular needs of any person or class of persons. You should seek advice from a licensed or an exempt financial adviser on the suitability of a product for you, taking into account these factors before making a commitment to purchase any product or invest in an investment. In the event that you choose not to seek advice from a licensed or an exempt financial adviser, you should carefully consider whether the product or service described herein is suitable for you.
You are fully responsible for your investment decision, including whether the investment is suitable for you. The products/services involved are not principal-protected and you may lose all or part of your original investment amount.
Standard Chartered Bank (Singapore) Limited will not accept any responsibility or liability of any kind, with respect to the accuracy or completeness of information in this article.
Deposit Insurance Scheme
Singapore dollar deposits of non-bank depositors are insured by the Singapore Deposit Insurance Corporation, for up to S$100,000 in aggregate per depositor per Scheme member by law. For clarity, these investment products are not deposits and do not qualify as an insured deposit under the Singapore Deposit Insurance and Policy Owners’ Protection Schemes Act 2011. Foreign currency deposits, dual currency investments, structured deposits and other investment products are not insured.
The information stated in this article is accurate as at the date of publication.
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