Demystifying the pause in dollar decline

Dec 11 2013, 03:16 IST
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SummaryThe dollar’s resilience as the world’s reserve currency is due to a lack of good alternatives—the euro has its own problems, and the yuan only accounts for 2.2% of forex transactions

As most people know, the general trend in the dollar’s role as an international currency has been slowly downward since 1976. International use of the dollar as a currency in which to hold foreign-exchange reserves, to denominate financial transactions, to invoice trade, and to serve as a vehicle for foreign-exchange transactions is below where it was during the heyday of the Bretton Woods era (1945-1971). However, few are aware of what the most recent numbers show.

It is not hard to think of explanations for the downward trend:

* Since the time of the Vietnam War, US budget deficits, money creation, and current-account deficits have often been high. Presumably as a result, the dollar has lost value in terms of other major currencies and in terms of purchasing power over goods.

* The US share of global output has declined.

* The disturbing willingness of some US congressmen in October to pursue a strategy that would have the Treasury default on legal obligations has led some observers to question the dollar’s international currency status.

* Some Emerging Market currencies are joining the list of international currencies for the first time. Indeed, some analysts have suggested that the Chinese yuan may rival the dollar as the leading international currency by the end of the decade!

The dollar’s trend as an international currency has not been uniformly downward, however. The periods when the public is most concerned about the issue do not coincide well with the periods when the dollar’s share is in fact falling. By the criteria of international use as a reserve currency among central banks and as vehicle currency in foreign exchange markets, the most rapid declines took place during the intervals 1978-1991 and 2001-2010. (The yen and deutschemark were the rising currencies during the first period, and the euro during the second.)

In between these two intervals, during the years 1992-2000, there was a clear reversal of the trend, notwithstanding a popular orgy of dollar declinism around the middle of that decade. Central banks held only an estimated 46% of their foreign exchange reserves in the form of dollars in 1992, but had returned to almost 70% by 2000.

Subsequently, the long-term downward trend resumed. According to one estimate, the share in reserves declined from about 70% in 2001 to barely 60% in 2010. During the same decade, the dollar’s share in the foreign exchange market also declined—the currency constituted one side or the other in

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