The Dollar’s Role: Prospects

From D. Fried, CBO Working Paper (summary):

The U.S. dollar plays an important role as the most widely used currency in global goods,
services, and financial markets. Strong international demand for U.S. dollars and dollardenominated assets associated with the dollar’s status as an international currency has increased the value of the dollar in foreign exchange markets and the value of dollar-denominated assets in financial markets. As a result, the dollar’s status has contributed to persistent U.S. trade deficits and, by lowering interest rates, to increased access to credit for U.S. households, businesses, and the federal government. Over the next decade, the dollar’s international use is expected to decline very gradually, in the Congressional Budget Office’s assessment, but it will not be overtaken by either of its closest competitors, the euro or the Chinese renminbi.

As one who’s tried to estimate empirical models of reserve currency holdings, I know the limitations of what econometrics can glean from the post-War period, in the context of highly persistent shares. Hence, useful to read the last para from the history portion of the paper :

The best assets to be used as foreign exchange reserves are those backed by credible authorities, with open capital markets. Great Britain was one of the first nations to commit to convertibility for their currency and, by successfully maintaining their peg over decades, established the pound as a credible store of value. By virtue of having maintained their gold standard for longer than all other countries, British assets were generally deemed internationally credible. In addition, Great Britain had a well-developed financial system and was the world’s largest gold market. As a result of both of those characteristics, the pound was the most widely used currency for foreign exchange reserves. (p.11)

Key words to remember — credibility, open capital markets, convertibility — when one contemplates graphs like this.

Source: Fried (2023).

As Eichengreen has noted, this observation does not preclude the RMB becoming an important regional currency, in trading, and other transactions. For more skeptical observations on the RMB overtaking the dollar anytime soon, see this post. See also Mark Sobel‘s discussion at UW Madison in last month.

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