The Decline of the US Dollar: A Shift in Global Reserve Currency Dynamics

The results are out!

The US dollar lost a chunk of market share, as the dollar’s share of global reserves has fallen. Stephen Jen’s suggests that after adjusting price changes, the dollar’s share of global reserve has fallen from ~73% in 2001 to ~47% in 2022.

This erosion in reserve status has accelerated since the start of the Ukraine war. Sanctions on Russia such as freezing Russian central bank assets, incentivized large reserve-holding countries - mostly from the Global South - to reduce their USD holdings.
This fragmentation of the financial system got countries renegotiating the currency in which they get paid for trade. While war rages on, trade with Russia for some countries like India and China continues through alternate channels.

“Wars also upend the dominance of currencies and serve as a doula to the birth of new monetary systems,” says Zoltan Pozsar, analyst at Credit Suisse.
The main beneficiaries of USD market share drop have been the Yen and Euro — whose price-adjusted reserve market share surged 5% in 2022. But don’t sound the death knell on the USD just yet

There are two pillars that make the USD mighty:
1. Its role as the reserve currency of choice
2. The dominant use in global finance/trade

As most cross border trades are completed in USD, it reinforces USD’s role as reserve currency of choice. Countries stash their rainy-day money in a currency in which they can buy/borrow, and stable.
Currently, no market has the breath to challenge the USD. But that could change in a couple of decades.

With the RMB, yen or euro, financial markets growing and offering stability, they could slowly but steadily overshadowing the US market.
It is possible that countries build a multi-currency reserve system where the dollar is playing an equal role to the RMB, dollar, yen or euro. Then, shocks originating from the US will have less of an impact on another countries economy as they would have been holding a basket of currencies in reserve.

For example, the current banking crises with the Fed hiking up interest rates, negatively affecting SVB finances which imploded as well as an increased crisis of confidence in Credit Suisse. In a world where there is a diversified basket of global reserve currencies this could have played out differently, authorities could have taken steps to insulate the Swiss bank from US policy.

That’s a big deal, especially for emerging markets because they will be able to focus more on what’s happening in their domestic economy and set policy according to domestic fundamentals. Then assets such as domestic equities will trade on domestic fundamentals and will be less responsive to the happenings in the US.

As investors it would make sense that we start hedging from today given that the world of FX will remain volatile for a while, and as some say the US dollar's dominance has peaked, the road is still long and turbulent.