It is not a question of “if” but of “when”. The dollar will not always be the world’s reserve currency. Eventually something else will replace it, perhaps another country’s currency or some other asset or commodity. But the dollar’s dominance will not end anytime soon, despite the rise of China, cryptocurrencies, or the prospect of another Cold War.
The global financial system still depends on the dollar. Many transactions are priced and transacted in dollars, even when transacted thousands of miles from US shores. Countries hold dollars and US bonds to stabilize their currencies. The special status of the dollar keeps its value high and relatively stable, and keeps our interest rates low and the bond market liquid, even, or rather especially, in times of crisis. The dominance of the dollar also has costs: the demand for dollars makes them more expensive, which hurts the US export sector. But at the end of the day, having the world’s reserve currency is a extremely valuable asset.
However, the future of the dollar now looks less certain than it did ten or even five years ago. The crippling sanctions imposed on the Russian economy remind countries how vulnerable they are to US government policies, as long as they have so many dollars. Falling out of favor with the US can result in economic devastation.
China, which is becoming an economic rival to the US, aspires to make the renminbi an alternative to the dollar. Its central bank is offering renminbi swap lines, which would provide liquidity to China’s friendly central banks when they need it. China is also acting as an alternative to the IMF, offering bailouts to developing countries—and creating financial dependency in their economy. Beijing is also building infrastructure in such countries, playing a role most often played by the World Bank.
Meanwhile, the United States has abused its position, racking up a lot of debt and moving slowly to control inflation. Both actions make the value of the dollar much less attractive and much less secure.
But there are still no viable alternatives to the dollar as a reserve currency. Very few foreign exchange and bond markets are as large and liquid as those in the US. Despite China’s efforts over the past decade to become a global competitor, the portion of the world’s foreign exchange reserves held in renminbi is only 2 percent, compared to 60 percent in US dollars. The renminbi will most likely never take off, because the Chinese manipulate the value of their currency, disqualifying it from reserve currency status. Despite all the Federal Reserve bond purchases, the value of the dollar is established in the market, making it much more reliable and liquid. Currency manipulation tracks Beijing’s political goals, which can be unpredictable, especially in times of uncertainty. Unless the Chinese government fully commits to being a market economy and floating its currency, the renminbi will never be a reliable store of value. And none of those things will happen soon. Meanwhile, cryptocurrencies and gold are also not viable candidates. They are more volatile than the dollar, and ultimately the dollar is less risky because it is backed by big government and American goods and services.
Given its loose monetary policy, the United States does not deserve its good fortune, but for now, dollar dominance is safe.