Future of the US Dollar as a Reserve Currency

Reports of the demise of the US Dollar as a reserve currency are greatly exaggerated, yet it is likely that role of the dollar is likely to diminish steadily in central bank reserve portfolios over the coming decade. The US Dollar has been weakened as a reserve currency by uncertainties over US fiscal policy and whether debt ceiling debates could result in a short-lived technical default on US Treasury securities by the US Federal Government.

The US Dollar has been further weakened as a reserve currency by uncertainties over US monetary policy and especially over the size of the Federal Reserve and its role in credit markets as a result of its quantitative easing programs. As yet, only the Euro might be considerable a viable competitor to the US Dollar as a primary reserve currency, but the long-term fate of the Euro is also shrouded in uncertainty.

Once China allows for full normalization of the RMB and develops a deep and liquid Chinese government debt market with related futures and options markets, then central banks will probably start incrementally to add RMB exposures to their international reserve portfolios.

Gold continues to play a role in central bank international reserve portfolios, but nothing like it did under the Bretton Woods exchange rate system which was disbanded in 1971.

The real competitor to the US Dollar in central bank portfolios is the desire to enhance investment performance and to manage investment risks through portfolio diversification. One can easily develop scenarios where the share of the US dollar in reserve portfolios declines as central banks move toward greater currency diversification of their assets.
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