## The US dollar might slip, but it will continue to rule

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**Canonical URL:** [The US dollar might slip, but it will continue to rule](https://www.imf.org/-/media/files/publications/fandd/article/2022/june/prasad.pdf)

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### Overview
- The international monetary system faces potential change from economic, geopolitical, and technological forces, but whether these will displace the US dollar as the dominant international currency is uncertain.
- Financial power is a key element of soft power; the dollar currently dominates multiple dimensions of global finance.

### Dollar dominance: current state and implications
- Nearly 60 percent of the world’s central banks' foreign exchange reserves are invested in dollar-denominated assets.
- Almost all commodity contracts, including those for oil, are priced and settled in dollars.
- The dollar denominates and settles a majority of international financial transactions.
- The preeminence of the dollar allows the United States to exert influence through sanctions and means US fiscal and monetary policy strongly affect other countries.

### Shifts underway in the global economy
- Raw US economic dominance: the US economy accounts for about 25 percent of global GDP (at market exchange rates), down from 30 percent in 2000.
- The locus of economic power has been shifting toward emerging market economies, led by China.
- Foreign exchange markets: transactions between pairs of emerging market currencies are becoming easier as markets and payment systems mature, reducing reliance on vehicle currencies like the dollar.

### Digital currencies and payment-system innovations
- New technologies from the cryptocurrency revolution enable cheaper and near-instantaneous cross-border payments and settlements.
- Central banks are experimenting with central bank digital currencies (CBDCs); China is in advanced trials of its CBDC.
- China’s Cross-Border Interbank System (CIPS) can communicate directly with other countries’ payment systems and will enhance the renminbi’s role as an international payment currency.
- Renminbi metrics:
  - Used for about 3 percent of international payment transactions.
  - About 3 percent of global foreign exchange reserves are held in renminbi.
- Caveats on renminbi as reserve currency:
  - Renminbi lacks certain attributes reserve currencies typically need: fully market-determined institutions like an independent central bank and the rule of law.
  - The renminbi is not fully convertible.

### Effects on trade, remittances, and emerging markets
- Faster settlement reduces exchange-rate-volatility risk, lowering hedging needs for exporters and importers and reducing remittance fees.
- New financial technologies will improve access to global finance for firms and households in emerging market and developing economies.
- Countervailing risks:
  - Proliferation of cross-border conduits intensifies vulnerability to major central banks’ policies and investor sentiment.
  - Capital controls may become less effective; cryptocurrencies have been channels for capital flight.
  - Greater capital flow and exchange-rate volatility complicate domestic policy management and can harm economic and financial stability.
- Responses by emerging-market policymakers may include expanding foreign exchange reserves, but such buffers may be inaccessible under sanctions (example: Russia’s loss of access to the bulk of its foreign exchange reserves).

### Alternatives to dollar reserves: limitations
- Gold: markets lack sufficient liquidity to serve as a viable alternative in large-scale sales without triggering price plunges.
- Cryptocurrencies (e.g., Bitcoin): highly unstable in value, unsuitable as reliable reserve assets.
- Renminbi: limited help because of partial convertibility and institutional constraints.
- Modest diversification has increased shares of Australian, Canadian, and New Zealand dollars in global foreign exchange reserves, but these have only marginally dented the US dollar’s share.

### Risks of currency displacement and likely outcomes
- Small and less developed economies risk having their national currencies displaced by stablecoins or major-economy CBDCs; economic turmoil could further dollarize economies.
- Digital versions of well-known currencies may accelerate dollarization.
- New technologies could either decentralize currency competition or produce greater centralization with some currencies gaining more power—possibly reinforcing the dollar’s dominance.

### The "dollar trap" and balance-sheet asymmetries
- Foreign investors, including central banks, hold nearly $8 trillion in US government debt.
- Overall US financial obligations to the rest of the world total $53 trillion.
- US investors’ holdings of foreign assets amount to about $35 trillion and are denominated almost entirely in foreign currencies.
- A sharp fall in the dollar would reduce the value of dollar-denominated assets for foreign holders (e.g., China’s holdings of US government bonds would be worth less in renminbi), while increasing the dollar value of US investors’ foreign assets—creating a net windfall to the United States and losses to the rest of the world.
- This asymmetric outcome makes a sudden dollar collapse painful for other countries and contributes to a persistent "dollar trap."

### Conclusion and outlook
- The dollar’s role as the dominant reserve currency will likely persist, even if its status as a payment currency erodes (which itself is uncertain).
- A likelier prospect is a reshuffling of the relative importance of other currencies while the dollar retains primacy.
- New technologies and geopolitical developments might entrench, rather than weaken, the dollar’s dominance.

*Source: prasad*

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_Source: https://www.imf.org/-/media/files/publications/fandd/article/2022/june/prasad.pdf_