Currency Chatter: Discussion on the USD's Reserve Currency Status
Introduction: USD Losing its Reserve Currency Status
We have received numerous questions from investors about the news of the USD potentially losing its reserve currency status due to emerging market economies agreeing to transact directly without the dollar intermediary. Therefore, we share a few reasons why you should not worry about this.
Global Currency Share
Firstly, according to the International Monetary Fund (IMF), the U.S. dollar still comprised approximately 58% of global foreign exchange reserves in the fourth quarter of 2022, while the Euro, the second most widely held reserve currency, accounted for roughly 20%. The substantial gap between the USD and its closest competitor demonstrates the dollar's entrenched position in international finance.
Secondly, the U.S. dollar is the primary currency for invoicing and settling international trade transactions. The Bank for International Settlements (BIS) estimates that about 40% of global trade is still invoiced in USD. This widespread use of the dollar in global trade creates persistent demand for the currency, further solidifying its status as the dominant reserve currency.
Yuan vs. USD
Thirdly, much has been said about Chinese holdings of U.S. federal debt. It's important to acknowledge that China owns less than 4% of the debt. Their purchase of this debt, through their substantial holdings of U.S. Treasury bonds, has played a vital role in maintaining the country's competitive edge in international trade. By accumulating large amounts of U.S. Treasuries, China effectively keeps the value of its currency, the yuan, relatively low compared to the U.S. dollar. A weaker yuan boosts China's exports by making them more affordable for foreign buyers, contributing to its trade surplus. If China significantly reduced its holdings of U.S. Treasuries, it would lead to an appreciation of the yuan against the dollar, making Chinese exports more expensive and less competitive in international markets. Consequently, China has a vested interest in maintaining the status quo, as a strong U.S. dollar benefits its export-driven economy. This interdependence between the U.S. and China adds another layer of stability to the dollar's role as the world's primary reserve currency and further underscores the challenges in replacing the dollar in the global financial system.
Lastly, while it is true that emerging market economies are increasingly exploring alternatives to the U.S. dollar for trade and financial transactions, the transition away from the dollar's reserve currency status is likely to be a slow and gradual process. The existing infrastructure, liquidity, and stability provided by the U.S. financial markets, along with the deeply entrenched position of the dollar in international finance, will not be easily supplanted.
Conclusion: Other Remarks
However, regardless of all this talk, holding USD in a bank account is not a sound wealth management strategy. Cash is designed to lose value over time. We recommend that cash only be held as an emergency cash fund —this includes the cash you may need in an emergency, as well as a reserve of what you know you will definitely be spending above what your income can afford you in the next 2 to 3 years (e.g., a house purchase that you know you'll be making next year).
Ownership of real assets has always been the solution to a surplus of cash, which includes the ownership of companies. Equities are the best option to own real assets, as they provide the ability to heavily diversify your ownership and its accompanying risks. By owning a diversified portfolio of company ownership, you own the production of these assets. Even though this production is currently in USD, you own the production regardless of the currency it is being sold in. Should the USD lose value, the earnings go up as the prices of production do too.
The devaluation of currency through inflation is a nudge for holders of wealth to put their funds to use in owning productive assets. In essence, investors must focus on owning real assets rather than hoarding cash, as this will better protect their wealth in the long run.
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