The US Dollar Is Still the Master

The U.S. dollar’s loss of its international status as the world’s essential exchange currency and basic reserve currency, preserved by central banks for particular purposes, has increasingly become a conversation piece. We have started to read about alternative scenarios to the era of the dollar, which is over and approaches its decline. Also, the designation of alternative currencies has spread at a wide range, particularly regarding the euro or the Chinese yuan. Rather, some countries, such as the Albraix group, have reached an agreement to use their national currencies in the settlement of the value of commercial transactions with each other instead of the dollar, which is considered by some as representing a terrible blow to the international status of the dollar. The latter are not wondering about the proportion of inter-business transactions for these countries with respect to the total daily demand within the foreign exchange market, which currently exceeds four trillion dollars a day and is performed mainly in U.S. dollars.

It is worth mentioning that the world has recently been witnessing an increase in the international role of some non-traditional currencies, such as the Swiss franc, Australian dollar and Canadian dollar, which are increasingly used day after day. Yet, the relative importance of these currencies is still limited to a large extent. Also, the use of these currencies at the international scope is almost confined in the settlement of inter-business transactions, which represents a small proportion of the total daily demand for currencies in the global market for foreign exchange.

Realistically, the situation on the ground is not as bad as suggested by observers’ analysis in this area. Day after day, reports prove that the international situation of the dollar has not deteriorated as some writers point out or as others are trying to convince us. The dollar is still the world’s basic currency of exchange and the major reserve currency for central banks of all the countries of the world. A few days ago, the International Monetary Fund issued its most recent report about the world’s gross reserves for foreign exchange. It contains the latest statistics related to the central banks’ reserves for foreign exchange for 139 countries until the third quarter of 2011. Also, it includes international reserves, claimed by non-residents (foreigners) in the form of liquid foreign currencies, bank reserves in foreign currencies, treasury bills, short- and long-term government bonds to foreign governments and other claims in foreign currencies suitable for use in the balance of payment needs. This chart shows the evolution of foreign exchange reserves over the past five years, which can be divided into two types: earmarked reserves, which are intended to indicate the reserves of central banks of countries that provide data to the Fund on the details of their allocation of the reserves in foreign currency, and non-earmarked reserves, including those belonging to countries that do not provide data to the International Monetary Fund on how they allocate their reserves, as well as any gaps in data on reserves submitted to the Fund. From the above table, it becomes clear that:

*The central banks’ reserves of foreign currency in the world have increased from $6.7 trillion in 2007, when the mortgage market crisis broke out in the United States, to about $10.2 trillion in the third quarter of 2011. This includes earmarked reserves that rose from $4.1 trillion to 5.4 trillion dollars respectively. Meanwhile, non-earmarked reserves increased from almost $2.6 trillion to $4.7 trillion, respectively.

*Within the earmarked reserves, demand for the U.S. dollar increased in the total reserves of the world countries from $2.6 trillion in 2007, an increase rate of 64.1 percent of the total allocated reserves, to about $3.4 trillion in the third quarter of last year, an increase rate of 61.7 percent of the reserves allocated. The only currency that can be said to rival the dollar as a relatively global reserve currency is the euro, for which demand has increased from $1.1 trillion in 2007, an increase rate of 26.3 percent of the total allocated reserves, to $1.4 trillion, at a rate of 25.7 percent of the total allocated reserves in the third quarter of 2011.

*According to the latest available data, between the second and third quarters of last year, central banks’ demand for U.S. dollar grew from $3.298 trillion to $3.36 trillion, respectively, while demand for the euro declined from $1.458 trillion to $1.4 trillion respectively.

*The world’s central banks’ demand for the other currencies (particularly the pound sterling, the Japanese yen and the Swiss franc, as well as other currencies, such as the Canadian dollar and the Australian dollar) has increased from $395 billion in 2007, 9.6 percent of the total reserves allocated, to $684 billion in the third quarter of 2011, a rate of 12.6 percent. However, between the second and third quarters of last year, the demand for these currencies decreased from $711 billion to $684 billion.

*These developments indicate that the third quarter of 2011 witnessed a decline in demand for all currencies in the international reserves of central banks with the exception of the U.S. dollar, for which demand has continued to increase.

On the other hand, if we try to follow the demand for international reserves, according to the diverse groups of the world countries, we will notice that:

*The developed countries’ demand for the U.S. dollar has increased from $1.423 trillion in 2007 to $1.915 trillion in the third quarter of 2011. Also, the demand of this group for the euro has increased from $522 billion to $698 billion, respectively. Demand from developing and emerging countries for the dollar has grown from $1.218 trillion to $1.446 trillion respectively. Meanwhile, demand from this group of countries for the euro has grown from $560 billion to $703 billion, respectively.

*Between the second and third quarters of 2011, developed countries’ demand for the dollar grew from $1.791 trillion to $1.915 trillion, while their demand for for the euro during the same period witnessed a limited decline from $707 billion to $698 billion, respectively. As for developing and emerging countries, their demand for the dollar reserves has declined from $1.507 trillion to $1.446 trillion, as well as their demand for euro reserves, from $751 billion to $703 billion, respectively.

*In summary, past developments indicate that, generally speaking, demand for the U.S. dollar continues to increase, in spite of the difficulties it has been suffering since the beginning of the second millennium. To date, it is still the world’s major currency, either in exchange or in the reserve. Although there are attempts to substitute the U.S. dollar with other currencies in the world’s reserves of foreign exchange, the demand for these currencies is still limited within a narrow range against the total world reserves of foreign exchange. The recent developments with the euro make the U.S. dollar the undisputed master, in view of the noticeable characteristics the dollar enjoys. The most important of these is that it represents the currency of the world’s strongest economy, that the U.S. has the largest money market in the world and that the United States has the absolutely largest debt in the world. Currently estimated at $15.2 trillion, this huge debt, classified as the best sovereign debt the world, particularly the short-term portion, offers central banks an important feature. It takes advantage of their foreign exchange reserves through investing in this debt and enjoying the advantage of these reserves’ liquidity at the same time.