By Devin Loughin

The international financial ecosystem has been subtly shifting away from a heavy dependence on the U.S. dollar. This transition is influenced by a myriad of factors, including geopolitical shifts, economic evolutions, the emergence of alternative currencies, and concerns about the U.S. credit rating due to the potential default on its national debt.

Current State of Affairs:

In the wake of sanctions imposed on Russia by the United States in early 2022, following the invasion of Ukraine, there has been conjecture about countries outside the U.S. alliance diversifying their currency reserves. This speculation has begun to materialize. The BRICS nations (Brazil, Russia, India, and South Africa) are exploring the creation of a new currency to rival the U.S. dollar, aiming to exert greater control over their economic landscapes. As evidenced by the Euro, the birth of a new currency is a monumental task, necessitating intricate coordination among all participating nations. Regardless of whether this new currency materializes, other factors are contributing to the diminishing dominance of the U.S. dollar. Notably, the U.S. dollar’s share of central bank foreign reserves has recently reached its lowest point in two decades. Furthermore, the use of the U.S. dollar as a tool for imposing sanctions has led to increased concerns about a “weaponized” dollar, further fueling the drive for alternatives.

Despite the uncertainty, U.S. Treasuries continue to be a safe haven for capital worldwide. This was exemplified in 2011 when the U.S. credit was downgraded for the first time in history. Rather than sparking a sell-off, the event led to a surge in Treasury purchases. This counterintuitive response was driven by rising fear and uncertainty about the potential impact of the downgrade, the unfolding European debt crisis, and concerns about a possible U.S. recession. In such uncertain times, investors typically flee risky assets such as stocks and seek refuge in perceived safe havens. Despite the downgrade, U.S. Treasuries remained a preferred choice due to their liquidity, price transparency, and the lack of genuine alternatives. Consequently, yields fell as buyers flooded into the market, driven by fear that other assets would react more severely than the dollar and treasuries would to a U.S. credit downgrade.

Alternatives:

Several alternatives to the U.S. dollar have been proposed and are being explored:

1. The Euro: While the Euro has established itself as a significant global currency, its potential to replace the U.S. dollar is limited by the economic disparities and political differences among the member countries of the European Union.

2. BRICS Currency: The BRICS nations, excluding China, are considering a new currency. However, the creation of a new currency is a complex process requiring significant coordination, and the economic and political diversity of these nations could pose significant challenges. Moreover, each of these nations has sometimes contradictory interests in creating a dollar alternative.

3. Cryptocurrencies: The U.S. is investigating the possibilities of a digital currency like the USDC, and cryptocurrencies like Bitcoin have gained traction. However, the volatility, regulatory concerns, and the lack of a centralized authority make cryptocurrencies a risky proposition as a global reserve currency.

4. Gold: Gold has traditionally been a hedge against the dollar. However, its value is subject to significant fluctuations, and it does not yield interest, limiting its utility as a reserve currency.

5. Chinese Yuan: The Chinese Yuan could be a potential contender as a global currency. However, for the Yuan to make a strong run at being a truly global currency, China would have to profoundly change the way their macroeconomic policies function. This includes addressing its current account surpluses, trade policies, and the openness of its financial markets. A strong global currency typically requires an open and transparent economic system, which is currently not fully aligned with China’s economic model. It’s worth noting that China’s Belt and Road initiatives have been primarily dollar-denominated, indicating a continued reliance on the U.S. dollar.

6. Something Else: The possibility of another alternative emerging exists, but it would need to overcome the challenges of acceptance, stability, and utility that limit the current alternatives.

Conclusion:

The world is gradually reducing its reliance on the US dollar, but this doesn’t necessarily mean another currency will take its place at the top soon. Just as we (financial advisors) discuss diversification amongst different investments and asset classes to mitigate risk, other countries are starting to diversify their reliance on the U.S. dollar.

Any opinions are those of the authors and not necessarily those of Raymond James. This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. Expressions of opinion are as of this date and are subject to change without notice.

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