How Much Longer Will The Dollar Remain The Reserve Currency Of The World?

by: Cullen Roche

The U.S. Dollar's status as a reserve currency seems to be a perennial concern for many people these days. I think this concern is often dramatically overstated. I was reminded of this point as I was reviewing the slides from Jeff Gundlach's presentation yesterday which showed the following chart:


(Source: DoubleLine)

As you can see, no one maintains reserve currency status forever. That shouldn't be remotely surprising. The global economy is dynamic and market shares shift. And at the end of the day that's what reserve status is really all about. Think about it - nations accumulate reserves of U.S. dollars today because the U.S. economy is the dominant player in global trade.

Of course, the U.S. Dollar isn't the only currency that nations maintain reserves of. The Euro is also a major reserve currency and the Yuan is fast becoming a major reserve currency. But since the USA produces 22% of all world output it happens to play a particularly special role in the global economy. By virtue of being the largest economy in the world the accumulation of U.S. dollar denominated financial assets happens to dominate the global financial system. It's sort of like being the top market share producer of a particular product in a particular industry. Other entities accumulate your products because you're the top producer. And that changes over time. Market shares change and regimes shift with the evolving economy.

So, will the USA lose its reserve currency status at some point? Yes. In fact, it's already starting to lose its reserve status to Europe and China. Will it be the end of the world and will it cause everyone to suddenly ditch the dollar? Probably not. It just means the USA will produce a lower proportion of global output and therefore, as a matter of accounting, the rest of the world will hold a lower percentage of U.S. dollar denominated financial assets as a percentage of global output. It's not the end of the world. It's just a sign that market shares change and when you're #1, well, there's only one direction to go.