Despite Detractors, Don't Buy Talk of Dollar's Demise

The demise of the U.S. dollar as the world’s go-to currency appears to have been greatly exaggerated.

Pointing to the scary 2008 financial crisis and America’s bloated budget deficit, greenback haters have predicted the eventual move away the dollar for years, suggesting potential alternatives like the euro, gold and China’s currency.

But the dollar’s status as the preeminent world currency doesn’t appear to be in serious jeopardy, especially because its rivals all have serious disadvantages and the U.S. is among the strongest-performing developed economies.

“We believe it premature to conclude…that the dollar will lose its reserve currency position,” Paul Christopher, chief international strategist at Wells Fargo Advisors (NYSE:WFC), wrote in a recent note to clients. “Investors should avoid jumping to conclusions.”

The loss of the dollar’s status as the world’s reserve currency would represent a huge hit to American prestige as well as the U.S. economy, which enjoys a strategic advantage from the rest of the globe's reliance on the greenback.

Thanks to its perceived relative safety, a reserve currency is one that is the preferred currency for accounts like commodities, as a medium of exchange from one currency to another and as a trusted store of value.

This is a status the U.S. dollar has enjoyed for decades, but has been challenged in recent years by some in China and in the Middle East who want to move away from the greenback.

Still on Top

Despite that pressure, a closer look leaves little doubt the U.S. dollar remains the world’s dominant currency.

From an accounting perspective, it’s clear the dollar is still the preferred currency settlement in global trade, even when the U.S. isn’t directly involved in the transaction.

“Pricing in dollars ensures that the parties may settle in a currency that is liquid and easy to obtain at competitive prices, anywhere in the world,” said Christopher.


It helps that many key commodity exchanges, such as the CME Group’s (NYSE:CME) Chicago Mercantile Exchange, are located inside the U.S. Likewise, Christopher notes that major oil exporters like Saudi Arabia “maintain extensive investments and debts in dollars,” meaning a switch to another reserve currency “could disrupt their portfolio returns.”

At the same time, the greenback remains pivotal in the foreign-exchange market.

According to the Bank for International Settlements, the U.S. dollar accounted for 84.9% of the $4 trillion in foreign exchange turnover in 2010, down just marginally from 89.9% in 2001. And that’s in the face of a 28% decrease in the dollar’s value between 2002 and 2011 against a basket of major currencies.

The dollar is “the unparalleled medium of exchange because it’s the world’s easiest currency to buy or sell,” said Christopher.

In another sign of its continued prowess, International Monetary Fund statistics show that the greenback continues to represent about 60% of total global exchange reserves in developed markets, virtually unchanged from a decade ago. Instead of diversifying away from the dollar, countries appear to moving away from the crisis-riddled euro.

Supremacy Challenged by Debt

Of course, the dollar’s Achilles heel is largely the same as that of the U.S. economy: the national debt north of $16 trillion that has called into question the ability of the currency to maintain its longevity.

“A paper currency has credibility only as long as people trust its purchasing power,” said Christopher. “If the U.S. is perceived as a borrower that cannot repay its loans, then international dollar holders could decide to sell their dollars to forestall a loss in purchasing power.”

This has been the central argument made by those who want the world to move to another reserve currency. The major problem in making that case, however, is that few if any viable alternatives stand ready to replace the dollar.

Marc Chandler, global head of currency strategy at Brown Brothers Harriman, said there would need to be a “clear, viable alternative,” not one that is simply the same as the U.S. dollar. He compared it with trying to replace the standard QWERTY-style keyboards. “It’s got to be a lot better than my current keyboard,” he said.

Lack of Alternatives

Since its debut in 1999, the euro has been touted as a possible future reserve currency.

“I didn’t believe it then and I still don’t believe it now,” Chandler said of the talk about the euro replacing the dollar atop the currency food chain.

The events of the past four years, highlighted by the bailouts of eurozone members Greece, Ireland, Portugal, Spain and Cyprus, have called into question the euro’s ability to remain in existence, let alone to replace the dollar.

Christopher said even if the “stress” from the eurozone’s recent problems are ignored, it’s worth noting that the European Central Bank doesn’t promote the euro as a reserve currency, in part because that could drive up the currency’s value and hurt exports.

While China continues to grow at a faster clip than the U.S., it doesn’t appear ready to lead the global currency markets.

A shift to a basket of Asian currencies anchored by China’s renminbi wouldn’t work because “China does not have a bond market deep enough nor is the market transparent enough,” Chandler said.

Others have suggested that gold, which is seen as a key hedge against inflation, or another commodity could replace the dollar.

But Christopher said “no commodity supply grows fast enough to support money growth adequate for the world’s economic growth.” He said this is one of the main reasons why “gold has not lasted very long in modern times as the backing for any currency.”

In addition to the lack of viable alternatives, the situation in the U.S. has meaningfully since the end of the economic downturn.

Gross domestic product growth in the U.S. has largely outperformed many other developed economies, the stock market continues to rally to new records and the shale oil energy boom could give the nation energy self-sufficiency by the end of the decade.

If this were a poker game, “I think we’d all want the U.S.'s cards,” said Chandler. “There are a lot of good things happening here.”