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FOR decades, this question has been resurfacing: Will the US dollar continue to be the world’s dominant reserve currency and continue to dominate the international monetary system?
The US dollar’s share of the world’s foreign exchange reserves has been falling gradually, and the structural changes in world economic and financial order as well the evolution of financial technology have weakened the dollar’s market share in global cross-borders payment systems.
The US Federal Reserve’s (Fed) resolve to get soaring inflation (9.1% in June 2022) back down to more acceptable level (Fed’s inflation target of 2%) through more interest rate hikes has helped to strengthen the dollar.
The broad US Dollar index, which had strengthened by 3.5% in 2021, continued to increase by 7.1% as of mid-July 2022.
Higher Treasury yields have made the US dollar more attractive to long-term investors, especially central banks and sovereign funds as they take into account the inflation’s return impact on their strategic allocation of assets and portfolio investment.
As of Aug 1 this year, at the levels (UST two-year at 2.8964%, five-year at 2.6911% and 10-year at 2.6590%), the US bond yields are becoming more attractive compared other comparable advanced and emerging bond markets.,
This will increase if US inflation starts to slow, which is likely to happen by 2023.
Enhancing the greenback’s appeal is the interest rate differential, which became a natural tail wind for the dollar. With the Fed’s hawkish bias to tackle inflation head on, and reinforced by quantitative tightening resulted in tighter financial conditions, this will prove a challenge for most assets classes and should help to buoy demand for the US dollar as a safe haven amid economic uncertainty and interest rate differential gains.
The US dollar’s dominant status as world reserve currency and its high liquidity has always been the investors’ undisputed safe haven currency choice.
In times of economic turmoil, investors’ flight to quality shed riskier assets and acquire less volatile ones.
This happened in 2008-2009 global financial crisis when the global demand for the US government bonds was held steady.
Will the US dollar lose its dominance status in the global international system? Over the years, structural changes in the world economic and financial order, geopolitical power play as well as the emergence of new technology and digital payment have undermined the US dollar’s role.
The US dollar’s share of global reserve currency has been shrinking to 58.9% in the first quarter of this year (1Q22) from 62.2% in 2010; 71.1% in 2000 and 65.1% in 1997. Have there been any significant shift into other reserve currencies?