Are the doomsters correct about the US dollar

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European

As avid followers of the financial blogosphere know, there is ongoing speculation about the dollar’s future, with some predicting an inevitable decline.

One recent post likened the U.S. to the Roman Empire, suggesting it has weakened itself relative to other global powers. The argument is that the dollar’s dominance in the global financial system is waning as policymakers appear to undermine capitalism. This narrative has persisted for over two decades, now intensified by geopolitical events such as the 2022 sanctions against Russia, which have prompted some countries to consider diversifying their reserves away from the dollar.

A coordinated global effort to reduce reliance on the dollar could potentially disrupt the U.S.’s ability to issue debt on favorable terms, significantly impacting markets and trade. However, evidence of this shift remains sparse. The share of global central bank reserves held in dollars has decreased from over 65% in 2016 to 58.4% by the end of 2023, while holdings in Chinese renminbi have increased but still only account for 2.3% of total reserves.

A recent New York Fed blog suggests that the perceived reduction in dollar reserves is largely due to a few countries, including Switzerland, which accumulated significant euros to manage its currency. From 2015 to 2021, 31 out of 55 countries actually increased their dollar reserves. The decrease is primarily driven by China, India, Russia, and Turkey, alongside Switzerland’s euro reserves.

Globally, central banks have increased gold purchases to mitigate sanctions risks, yet gold still comprises just 10% of total reserves. The New York Fed highlights that narratives about declining dollar shares and rising gold holdings often overgeneralize the actions of a few countries.

Gold enthusiasts and crypto supporters note that central banks are likely to continue increasing gold reserves. According to a survey by the Official Monetary and Financial Institutions Forum (OMFIF), despite high gold prices and easing inflation, reserve managers are inclined to boost their gold holdings.

Demand for the dollar remains strong. OMFIF’s survey, covering 73 central banks with $5.4 trillion in reserves, found a net 18% plan to increase their dollar holdings due to higher interest rates and a robust U.S. economy. The euro remains the second most popular reserve currency, while appetite for the renminbi has diminished, with 12% of managers planning to reduce their holdings in the Chinese currency. This shift is attributed to pessimism about China’s economic outlook, market transparency issues, and geopolitical concerns.

While it’s conceivable that the dollar’s long-term dominance could be challenged by deteriorating U.S. institutional resilience, it remains premature to predict the end of the dollar’s primacy in the global financial system.