Fate of the U.S. Dollar Flourish Insights

Episode #76: Fate of the U.S. Dollar

The U.S. Dollar has been the global reserve currency since 1944, when the Bretton Woods Agreement solidified the transition from the British Pound to U.S. Dollars. Recently, several clients have asked whether the U.S. Dollar can withstand challenges from growing currencies, like the Chinese Yuan, or from digital currencies. In this episode, we will review the history of currency markets, along with a deep dive into the strength of the U.S. Dollar compared to other major global currencies.

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EPISODE TRANSCRIPT

Hi everyone, Jay Pluimer here with Flourish Insights. As the director of investments at Flourish Wealth Management, I take pride in providing our clients, colleagues, and friends with resources and information that can help them make strategic and effective choices regarding their investments. Did you know we have an Alexa Skill? To listen on your Alexa device, just say, “Alexa, play Flourish Insights.”  

Today, in response to client questions, we are discussing the Fate of the US Dollar.
 
I appreciate when clients ask questions that challenge whether or not the foundations of the current market are sustainable in the future. Some of those questions relate to US versus International investments or the opportunities for a portfolio with 60% in Stocks and 40% in Bonds to earn an attractive return. An excellent example of client questions popped up recently when a couple different clients asked questions about the sustainability and reliability of the US Dollar as the global default currency. These questions challenged whether or not the US Dollar could withstand challenges from growing currencies like the Chinese Yuan or from digital currencies. It was a helpful opportunity to review the history of currency markets along with a deep dive into the strength of the US Dollar compared to other major global currencies.

The US Dollar has been the global reserve currency since 1944 when the Bretton Woods Agreement solidified the transition from the British Pound to US Dollars. This was a reflection of the balance of power for the United States as the largest economy in the world in the 1940s, a status that the US continues to hold. Although the definition of a reserve currency can be complicated, the most effective way to explain this status is that countries selling goods and services to the US and are paid in dollars, meaning that the more business a country does with the US the more dollars they have in their Treasury. For example, China is the second largest economy in the world and a major trade partner of the United States, resulting in China holding over 1 Trillion US Dollars. The result is that it would be very difficult for the Chinese Yuan to replace the US Dollar as the global currency because that would significantly reduce the value of one of the largest assets sustaining the value of their own currency.

The US Dollar represents about 60% of global foreign exchange reserves. The closest competitor is the Euro at 20% and no other currency represents more than 6%. A primary reason for the US Dollar to maintain its status as the global reserve currency is that it has consistently represented between 60% and 66% of global foreign exchange reserves, dominating all competitors by a significant margin. This consistency is impressive considering the introduction of the Euro as a global currency in 1999 and the entry of the Chinese Yuan in 2010. In addition, the US Dollar is valued relative to other currencies while the Chinese Yuan has an exchange rate that is controlled by the Chinese Government, an arrangement that has created complications for currency markets on a periodic basis over the years.

A final aspect to consider for a reserve currency is the percent of global transactions that take plac