The U.S. Dollar as the World’s Dominant Reserve Currency
Updated September 15, 2022
The U.S. Dollar as the World’s Dominant Reserve Currency
The U.S. dollar is the world’s dominant reserve currency,
backed securities like U.S. Treasury bonds, there is strong
among other such currencies including the euro, the yen,
demand for U.S. dollars. That demand, in turn, allows the
the pound, the renminbi (RMB), the Canadian dollar, the
United States to borrow more cheaply (at lower interest
Swiss franc, and the Australian dollar. A reserve currency is
rates) than it would otherwise.
a currency held by central banks in significant quantities. It
Strong demand for dollars also allows the U.S. government,
is widely used to conduct international trade and financial
firms, and consumers to borrow from foreign creditors in
transactions, eliminating the costs of settling transactions
dollars rather than foreign currencies. As a result, the value
involving different currencies.
of that debt does not depend on fluctuations in exchange
The dollar has functioned as the world’s dominant reserve
rates. When other governments, firms, and individuals
currency since World War II. Today, central banks hold
borrow in foreign currencies, they incur the risk that swings
about 60% of their foreign exchange reserves in dollars
in exchange rates will cause their real debt level (the size of
(Figure 1). About half of international trade is invoiced in
the debt in the borrower’s national currency) to increase,
dollars, and about half of all international loans and global
potentially quickly and significantly. U.S. firms and
debt securities are denominated in dollars. In foreign
consumers also benefit by saving on transaction costs.
exchange markets, where currencies are traded, dollars are
The widespread use of the dollar entails economic risks.
involved in nearly 90% of all transactions.
Low borrowing costs can lead to the accumulation of debt,
The dollar is the preferred currency for investors during
and the funds borrowed may not be channeled into
major economic crises, as a “safe haven” currency. During
productive investments. Additionally, the demand for the
the global financial crisis of 2008-2009, for example, and
dollar associated with its position as a reserve currency can
amidst the economic turmoil associated with the
lead to a stronger U.S. dollar. A strong U.S. dollar generally
Coronavirus Disease 2019 pandemic in 2020, investors
makes it harder for U.S. producers to compete in global
sought U.S. dollars, expecting the dollar to retain its value.
markets and can lead to persistent trade deficits, although
In both crises, the U.S. Federal Reserve adopted
U.S. consumers may benefit from less expensive imports.
extraordinary monetary authorities and currency swap lines
For example, the dollar has strengthened since mid-2021 as
with other central banks to provide liquidity and dollars.
the Fed tightened monetary policy to combat rising
inflation. In addition to the impact of a rising dollar on U.S.
Figure 1. Central Bank Reserves, Q2 2022
exporters, it will create challenges for many other countries
servicing their debts amidst higher interest rates and
slowing global economic growth.
Challenges to the U.S. Dollar’s Global
Role?
Historically, shifts from one dominant international
currency to another occur over many years. For example, in
the 20th century the U.S. dollar replaced the British pound
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.
Source: International Monetary Fund. Notes: 149 reporting
countries.
Some observers have speculated whether changes in the
global economy, and geopolitical shifts more generally,
Implications for the United States
could cause a shift from the dollar to other currencies.
The U.S. economy generally benefits from the dollar’s
Focus in particular is centered on China’s economic rise,
status as the world’s dominant reserve currency, once
U.S. sanctions, and digital currencies.
famously referred to as the United States’ “exorbitant
privilege” by France’s
China’s Global Economic Role
finance minister in the 1960s.
China’s growing role in the global economy since the 1990s
Because many central banks and financial institutions
around the world want to hold U.S. dollars and dollar-
has prompted China’s government to consider how to
promote the use of China’s currency, the RMB, in global
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The U.S. Dollar as the World’s Dominant Reserve Currency
trade. To date, this push has been limited by the
Russian exports. Additionally, European countries created a
government’s own caution in liberalizing China’s capital
special-purpose vehicle in 2019, the Instrument in Support
account, as well as investor concerns about potential risks
of Trade Exchanges (INSTEX), to facilitate non-dollar,
associated with the lack of transparency and predictability
humanitarian transactions with Iran to sidestep U.S.
of the government’s role in the market.
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 6th 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, but 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 in 2018 a consortium of companies led
sanctions and dollar leadership in certain instances.
by Facebook sought to create a new global digital currency,
U.S. Financial Sanctions
the libra, since abandoned. The JMP Coin is tied to the U.S.
dollar; libra was to be tied to a basket of currencies,
Through economic sanctions that impede access to the U.S.
including the dollar.
financial system (financial sanctions), the United States
leverages the role of the dollar to advance foreign policy
Many central banks are also researching, piloting, or have
objectives. Access to the U.S. financial system is generally
launched their own digital currencies. Unlike privately-
needed to settle transactions denominated in dollars, even
issued digital currencies, digital currencies issued by central
when both parties on the transaction are located outside the
bank serve or would serve as legal tender. According to a
United States. The U.S. government has increasingly
2021 BIS survey, 90% of central banks are engaged in work
restricted access to U.S. dollars and the U.S. financial
relating to the creation of digital currencies. Among major
system in an effort to alter the objectionable behavior of
economies, China is the furthest along in its development,
foreign governments. Most recently, the United States and
with several successful domestic and cross-border trials.
allies have imposed significant sanctions on Russia that
The U.S. Federal Reserve is currently evaluating a potential
impede the country’s ability to conduct many cross-border
central bank digital currency, but has not made a final
transactions.
determination.
Treasury officials in the Obama, Trump, and Biden
Some policymakers have expressed concerns about an
Administrations have cautioned that extensive use of
international race to create a digital currency with
financial sanctions could threaten the central role of the
widespread adoption, arguing that the United States should
dollar and U.S. financial system. Many foreign
create a U.S. digital currency to maintain the dollar’s
governments targeted by U.S. financial sanctions and their
prominence in international payments. Legislation pending
economic partners are increasingly exploring and creating
in the 117th Congress relates to the possible creation of a
ways to reduce their reliance on the U.S. dollar. Countries
digital dollar (for example, H.R. 2211, H.R. 3506, H.R.
are doing so through a variety of tools: contracts
6415/S. 3954,).
denominated in non-dollar currencies, currency swap lines,
digital currencies, and non-dollar payment processing
Potential Policy Issues for Congress
systems.
To date, there is no evidence of a shift away from the U.S.
dollar as the dominant reserve currency. However,
Figure 2. Russia’s Exports to Brazil, China, India, and
Congress may wish to:
South Africa: Currency Composition
analyze the benefits and costs to U.S. economic and
foreign policy interests from the dollar’s status in the
global economy;
continue monitoring how broad economic, political, and
technological shifts may affect the U.S. dollar’s status as
the dominant reserve currency;
consider implications of recent dollar appreciation on
U.S. and international monetary policy; and
consider how legislation in a range of policy areas,
including sanctions and digital currency, might impact
the dollar’s dominant reserve currency status.
Source: Bank of Russia.
Rebecca M. Nelson, Specialist in International Trade and
For example, the share of Russian exports to Brazil, India,
Finance
China, and South Africa invoiced in U.S. dollars fell from
Martin A. Weiss, Specialist in International Trade and
85% in Q2 2018 to 36% in Q4 2022 (Figure 2), although
Finance
these countries account for a relatively small share of total
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The U.S. Dollar as the World’s Dominant Reserve Currency
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