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December 18, 2020
The U.S. Dollar as the World’s Dominant Reserve Currency
The U.S. dollar is the world’s dominant reserve currency,
United States to borrow more cheaply (at lower interest
among other such currencies including the euro, the yen,
rates) than it would otherwise.
the pound, the renminbi (RMB), the Canadian dollar, the
Strong demand for dollars also allows the U.S. government,
Swiss franc, and the Australian dollar. A reserve currency is
firms, and consumers to borrow from foreign creditors in
a currency held by central banks in significant quantities. It
dollars rather than foreign currencies. As a result, the value
is widely used to conduct international trade and financial
of that debt does not depend on fluctuations in exchange
transactions, eliminating the costs of settling transactions
rates. When other governments, firms, and individuals
involving different currencies.
borrow in foreign currencies, they incur the risk that swings
The dollar has functioned as the world’s dominant reserve
in exchange rates will cause their real debt level (the size of
the debt in the borrower’s national currency) to increase,
currency since World War II. Today, central banks hold
potentially quickly and significantly. U.S. firms and
about 60% of their foreign exchange reserves in dollars
consumers also benefit by saving on transaction costs.
(Figure 1). About half of international trade is invoiced in
dollars, and about half of all international loans and global
The widespread use of the dollar entails economic risks.
debt securities are denominated in dollars. In foreign
Low borrowing costs can lead to the accumulation of debt,
exchange markets, where currencies are traded, dollars are
and the funds borrowed may not be channeled into
involved in nearly 90% of all transactions.
productive investments. Additionally, the demand for the
dollar associated with its position as a reserve currency can
The dollar is the preferred currency for investors during
lead to a stronger U.S. dollar. A strong U.S. dollar generally
major economic crises, as a “safe haven” currency. During
makes it harder for U.S. producers to compete in global
the global financial crisis of 2008-2009, for example, and
markets and can lead to persistent trade deficits, although
amidst the economic turmoil associated with the
U.S. consumers may benefit from less expensive imports.
Coronavirus Disease 2019 pandemic in 2020, investors
sought U.S. dollars, expecting the dollar to retain its value.
Challenges to the U.S. Dollar’s Global
In both crises, the U.S. Federal Reserve adopted
Role?
extraordinary monetary authorities and currency swap lines
Historically, shifts from one dominant international
with other central banks to provide liquidity and dollars.
currency to another occur over many years. For example, in
the 20th century the U.S. dollar replaced the British pound
Figure 1. Central Bank Reserves, Q2 2020
sterling as the dominant international currency over many
decades (including two World Wars and the Great
Depression) after the United States overtook the United
Kingdom as the world’s largest economy and exporter. The
U.S. dollar has persisted for seven decades as the world’s
dominant reserve currency through a number of major
shifts, including the collapse of fixed exchange rates, trade
and financial globalization, technological development, and
geopolitical changes.
Some observers have speculated whether changes in the
global economy, and geopolitical shifts more generally,
could cause a shift from the dollar to other currencies.
Focus in particular is centered on China’s economic rise,
U.S. sanctions, and digital currencies.
China’s Global Economic Role
Source: International Monetary Fund. Notes: 149 reporting
China’s growing role in the global economy since the 1990s
countries.
has prompted China’s government to consider how to
Implications for the United States
promote the use of China’s currency, the RMB, in global
The U.S. economy generally benefits from the dollar’s
trade, but to date, this push has been limited by the
status as the world’s dominant reserve currency, once
government’s own caution in liberalizing China’s capital
famously referred to as the United States’ “exorbitant
account, as well as investor concerns about potential risks
privilege” by France’s finance minister in the 1960s.
associated with the lack of transparency and predictability
Because many central banks and financial institutions
of the government’s role in the market.
around the world want to hold U.S. dollars and dollar-
China has experimented with pathways to denominate trade
backed securities like U.S. Treasury bonds, there is strong
in RMB, but the lack of RMB convertibility on the capital
demand for U.S. dollars. That demand, in turn, allows the
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The U.S. Dollar as the World’s Dominant Reserve Currency
account has posed a challenge, forcing China to rely on
For example, the share of Russian exports to Brazil, India,
currency markets in places like Hong Kong to cycle RMB
China, and South Africa invoiced in U.S. dollars fell from
back into China. China has piloted foreign investment in
85% in Q2 2018 to 33% in Q1 2020 (Figure 2), although
China’s domestic bond and stock markets. The government
these countries account for a relatively small share of total
has negotiated several central bank swap lines and is using
Russian exports. Additionally, European countries created a
One Belt, One Road projects to develop cross-border digital
special-purpose vehicle in 2019, the Instrument in Support
payments infrastructure. (For more, see CRS In Focus
of Trade Exchanges (INSTEX), to facilitate non-dollar,
IF10273, China’s “One Belt, One Road”, by Susan V.
humanitarian transactions with Iran to sidestep U.S.
Lawrence and Gabriel M. Nelson).
sanctions. INSTEX has completed one transaction to date.
The RMB plays a marginal role in international finance.
The Race to Create Widespread Digital Currencies
According to the Bank for International Settlements (BIS),
Over the past decade, the private sector has developed
the RMB is the 8th most traded currency. It is the sixth most
thousands of cryptocurrencies. A cryptocurrency is a digital
active currency for global payments by value, with a share
representation of value generally administered using
of 1.66 %. By contrast, the U.S. dollar and the euro
distributed ledger technology and has no status of legal
combined account for 75% of all transactions. China’s
tender. Cryptocurrencies remain a small, volatile, and niche
central bank is developing a digital currency to try to
market. Some large multinational corporations seek to
influence global finance and e-commerce, and diversify
create more stable digital currencies for use on a larger
from U.S. dollar financing. While such an effort may take
scale. For example, JP Morgan issued a digital coin (JMP
time to develop, it could allow China to challenge U.S.
Coin) in 2019, and a consortium of companies led by
sanctions and dollar leadership in certain instances.
Facebook is seeking to create a new global digital currency,
U.S. Financial Sanctions
the libra (rebranded as “diem” in December 2020 after
facing scrutiny from regulators worldwide). The JMP Coin
Through economic sanctions that impede access to the U.S.
is tied to the U.S. dollar; libra/diem would be tied to a
financial system (financial sanctions), the United States
basket of currencies, including the dollar.
leverages the role of the dollar to advance foreign policy
objectives. Access to the U.S. financial system is generally
Many central banks are also examining the creation of their
needed to settle transactions denominated in dollars, even
own digital currencies, which unlike privately-issued digital
when both parties on the transaction are located outside the
currencies, would serve as legal tender. According to a
United States. The U.S. government has increasingly
2020 BIS survey, about 80% of central banks are working
restricted access to U.S. dollars and the U.S. financial
on digital currencies. Many central banks accelerated their
system in an effort to alter the objectionable behavior of
work in response to the libra/diem project. The U.S. Federal
foreign governments, most notably Iran, Russia, and
Reserve is currently evaluating a potential central bank
Venezuela. Some policymakers have also considered
digital currency, but has not made a final determination.
financial sanctions in response to China’s recent actions
Some policymakers have expressed concerns about an
undermining the autonomy of Hong Kong.
international race to create a digital currency with
Treasury officials in the Obama and Trump Administrations
widespread adoption, arguing that the United States should
reportedly have cautioned that extensive use of financial
create a U.S. digital currency to maintain the dollar’s
sanctions could threaten the central role of the dollar and
prominence in international payments. Legislation has been
U.S. financial system. Many foreign governments targeted
introduced to create a digital dollar (for example, S. 3571,
by U.S. financial sanctions and their economic partners are
H.R. 6321, and H.R. 6553 in the 116th Congress).
increasingly exploring and creating ways to reduce their
Potential Policy Issues for Congress
reliance on the U.S. dollar. Countries are doing so through a
To date, there is no evidence of a shift away from the U.S.
variety of tools: contracts denominated in non-dollar
dollar as the dominant reserve currency. However,
currencies, currency swap lines, digital currencies, and non-
Congress may wish to:
dollar payment processing systems.
analyze the benefits and costs to U.S. economic and
Figure 2. Russia’s Exports to Brazil, China, India, and
foreign policy interests from the dollar’s status in the
South Africa: Currency Composition
global economy;
continue monitoring how broad economic, political, and
technological shifts may affect the U.S. dollar’s status as
the dominant reserve currency; and
consider how legislation in a range of policy areas,
including sanctions and digital currency, might impact
the dollar’s dominant reserve currency status.
Rebecca M. Nelson, Coordinator, Specialist in
International Trade and Finance
James K. Jackson, Specialist in International Trade and
Finance
Source: Bank of Russia.
Martin A. Weiss, Specialist in International Trade and
Finance
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The U.S. Dollar as the World’s Dominant Reserve Currency
IF11707
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https://crsreports.congress.gov | IF11707 · VERSION 1 · NEW