The Dollar is a Reserve Currency, Not “the” Reserve Currency

I continually get people asking me questions and sending me articles about how the dollar might lose its status as the world’s reserve currency and then something horrible is supposed to happen. Neither part of this story makes much sense and treating the issue in this manner confuses what is at stake.

As I, and many others, have pointed out, there is not a unique reserve currency. Many currencies, including the euro, the yen, the English pound, the Chinese renminbi, and even the Swiss franc are held as reserves by central banks. The dollar is the predominant reserve currency, but not the only one. It accounts for around 60% of central bank reserves at present.

There is a similar story with the dollar being used as the medium of exchange in international transactions. Again, most international transactions take place in dollars, but only a bit more than half of all trade. Just about all the trade between European countries is conducted in euros.

One of the great myths that has formed the basis of endless conspiracy theories is that oil must currently be traded in dollars. A popular story of the rationale for overthrowing Saddam Hussein was that he was going to start selling Iraq’s oil for euros.

This is absurd for two reasons. First, there was nothing ever stopping Iraq or any other country from selling oil for euros or any other currency. There is no international law that requires oil to be sold for dollars. If any country finds it more convenient to sell oil for yen or renminbi, as is sometimes the case, they use the alternative currencies.

The second reason that this sort of switch is no big deal is that it has very little to do with demand for dollars. Around 60 million barrels of oil are traded internationally each day, which at current market prices would sell for a bit more than $3.6 billion. That would be the amount of dollars buyers would need to acquire for their purchases if all oil was sold in dollars.

But it is important to recognize that no one needs to hold these dollars for any substantial period of time. A purchaser of oil could acquire the dollars they need minutes or even seconds before the transaction. The seller could also dump their dollars immediately after the sale. If people don’t want to hold dollars, the demand for conducting oil purchases is trivial in foreign exchange market with almost $10 trillion worth of daily transactions.

In short, the concern about the dollar losing its status as the reserve currency is silly. But there is a real issue with banks, pension funds, and other investors moving away from dollars. If there is less demand for dollars from investors, both foreign and domestic, it will fall in value relative to other currencies.

This is in fact exactly what we have seen since Trump came into the White House. In January of last year, it took just a little over a dollar to buy a euro. Currently, it takes almost $1.20 to buy a euro. The lower value of the dollar means that it costs more for people in the United States to buy imported goods, sort of like tariffs. That adds to inflation here.

It also means that it is more expensive for U.S. tourists to travel to Europe or other countries where the dollar has fallen relative to other currencies. It also means that U.S. companies looking to invest overseas will find it more expensive, as their dollars don’t go as far.

On the flip side, U.S. goods and services become cheaper for people living elsewhere. The U.S. also becomes cheaper as a tourist destination.

That means the overall picture is a mixed story. But as investors increasingly move away from the dollar because of Trump’s erratic foreign and domestic policies, we should anticipate a further decline in the dollar against most other major currencies. This is not a cataclysm, but it does mean that investors holding dollars will lose out relative to those who hold other currencies.

The key point here is that no one is making a zero-one decision about the dollar. Most banks, both central and private, corporations, pension funds, and wealthy individuals will hold some amount of dollar-based assets and some amount of assets in other currencies. When they see Trump’s erratic and destructive policies they will opt to keep a smaller share of their assets in dollars. Generally, that share will not go to zero, but some could make that call.

Envisioning a post-Trump world, where the United States again has stable policies and the rule of law, the dollar might look more like the English pound does today. It would still be a widely used international currency, but much less important than it is today.

This first appeared on Dean Baker’s Beat the Press blog.

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