It has often been declared dead, but is still unchallenged as a leading currency. Nevertheless, the dollar has lost some of its weight. This also has to do with Switzerland.
This year, many tourists are making the same observation during their summer vacation: it’s teeming with Americans. Hotels, restaurants and museums from various regions of the world are reporting an unusually high number of guests from the USA. This also applies to Switzerland. According to forecasts by BAK Economics, the United States will be responsible for 2.1 million overnight stays this summer. This would mean that the USA would even replace Germany as the largest foreign market of origin.
World currency and sanctions weapon
There are many reasons for the boom. One of the most important is the strength of the dollar. The American currency has gained in value compared to many other currencies in recent years, partly due to higher economic growth, tighter monetary policy and geopolitical uncertainty. The purchasing power of the dollar is correspondingly high. American tourists can afford more in many countries. This is noticeable in the affected countries: travelers from the USA have plenty of money to spend and are treating themselves to something.
But the dollar’s strength can quickly disappear. Foreign exchange markets are nervous trading places, the ups and downs of exchange rates follow erratic patterns and are hardly predictable. But even if the dollar should weaken soon, one thing has not changed for decades: its position as the world’s leading currency. Regardless of whether the dollar is in high demand or not, no other currency can even come close to the greenback in terms of global importance. If money rules the world, then the dollar rules money.
This dominance is not a given. The decline of the dollar is regularly predicted. New reasons are constantly being given to keep the belief in its decline alive. For several years now, this has included the argument that the USA is abusing its privilege as the issuer of the reserve currency as a weapon for sanctions, most recently against Russia, for example. The decision to decouple Russia from the dollar system and freeze its dollar reserves will prompt many countries to reduce their dependence on the dollar.
Three times as important as the euro
As convincing as the argument sounds, it has only been partially reflected in the data so far. The dollar is still the undisputed leading currency. Here are a few figures: 88 percent of all foreign exchange transactions involve the dollar. 54 percent of world trade is conducted in dollars. And 58 percent of all foreign exchange reserves held by central banks to strengthen confidence in their monetary policy or to be able to intervene against a possible weakening of their own currency are denominated in dollars.
The dominance seems unbroken. Nevertheless, it is true that the dollar has lost some of its weight on the global stage. The dollar’s share of the central banks’ and governments’ foreign exchange reserves, currently worth around 12 trillion dollars, has been falling for two decades. While the share was still over 70 percent in the early 2000s, it is now under 60 percent. But the decline is taking place at a leisurely pace. And the share is still almost three times as high as that of the second-ranking euro at 20 percent.
There is no broad-based move away from the dollar. This is also confirmed by an analysis by the Federal Reserve Bank of New York for the period from 2015 to 2021. During this time, the dollar share of foreign exchange reserves fell by 7 percentage points. However, the study shows that the decline is mainly due to the behavior of a few countries and not to the broad-based efforts of many central banks to move away from the dollar through greater diversification. Rather, 31 of the 55 countries examined have continued to increase their dollar holdings proportionally.
The subversive role of the SNB
But how can the 7 percentage point decline in the global dollar share be explained? The Swiss National Bank (SNB) plays an important role. According to the New York study, it is responsible for almost 1.8 percentage points of the decline. The SNB massively increased its foreign exchange reserves between 2015 and 2021, from 507 to 970 billion francs. In doing so, it mainly accumulated euro reserves to cushion the appreciation of the franc against the euro. This reduced the relative weight of the dollar.
The SNB wanted to use the foreign currency purchases to counteract the upward pressure on the Swiss franc. This was intended to protect the export industry from competitive disadvantages. It also wanted to prevent the strong Swiss franc from leading to deflation by making import prices cheaper. The Federal Reserve economists therefore stress that the strong accumulation of euros in Switzerland at the time was largely due to monetary policy “and not to a declining preference for dollar investments.”
The situation was quite different in Russia. There, too, foreign exchange reserves rose sharply between 2015 and 2021, by around 150 billion dollars. However, Moscow did want to reduce its dependence on the USA and therefore deliberately reduced the dollar share by 29 percentage points. This effect contributed a further 1.8 percentage points to the 7 percentage point decline in the dollar share of foreign exchange reserves. Countries such as China, India and Turkey also sought a similarly politically motivated move away from the dollar world in those years.
«Which de-dollarization?»
The decline in the dollar share at that time can therefore be attributed primarily to two factors: firstly, the sharp increase in foreign exchange reserves held by Switzerland for monetary policy reasons and secondly, the geopolitically motivated move away from the dollar in a small group of countries, which includes Russia, China, India and Turkey. The phenomenon is therefore geographically very limited. There can be no talk of a comprehensive move away from the dollar, even in the last few years.
This assessment is confirmed by the Official Monetary and Financial Institutions Forum (Omfif). The independent think tank surveyed 73 central banks, which together manage 5.4 trillion dollars in foreign exchange reserves. The survey published in June shows that 29 percent of central banks intend to increase their dollar investments in the next 12 to 24 months. This proportion is significantly higher than last year and represents greater additional demand than for any other currency. The euro comes in second with 16 percent.
“What de-dollarization?” is the question asked by Omfif. There is no sign of any distancing from the dollar. However, affection for the yuan seems to have cooled. Since the Chinese currency was included in the currency basket of the International Monetary Fund (IMF) in October 2016, its weight in foreign exchange reserves has fallen far short of expectations. The yuan reached its highest share at the end of 2021 at 2.8 percent, and since then the ratio has steadily fallen to just under 2.2 percent.
Euro, yuan and gold are not competitors
Since the increasingly authoritarian behavior of the Beijing leadership, the yuan’s greatest weakness – a currency with too much state – can no longer be concealed. As long as this remains the case and the regime relies on rigid capital controls, China’s plan to internationalize the yuan will remain a pious wish. The euro is also no serious competitor to the dollar. Since the euro crisis, the greatest weakness of the European single currency – a currency without a state – has been obvious to everyone.
A radical alternative to the dollar would be gold. Those who invest their reserves in precious metals instead of foreign currency can store them in their own country and are not exposed to the risk of their assets suddenly being frozen due to sanctions. IMF analyses show that sanctions have actually led to such shifts in the past. But gold has several disadvantages compared to foreign currency: it is expensive to transport, store and insure. It is also not very suitable as a means of payment and does not yield any interest.
Central banks have increased their gold reserves since the financial crisis, which was exacerbated by the war in Ukraine and increased inflation. However, its global significance is limited. Gold only accounts for around 10 percent of central bank reserves. In addition, IMF data shows that a few countries account for the majority of the shifts. More than half of the increase in gold reported since 2009 is attributable to China and Russia, and another quarter to the emerging countries of Turkey, India, Kazakhstan, Uzbekistan and Thailand.
Everyone uses it because others use it too
There seems to be no cure for the dollar. Its advantages as a reserve currency are obvious. The dollar is not only backed by the largest military and economic power, which is responsible for a quarter of the global gross domestic product. In addition, the American financial market is the most liquid and open. It is therefore easy to invest in dollars. Ultimately, however, it is above all the network effects that speak in favor of the currency. It is like WhatsApp: everyone uses the dollar because everyone else uses it too.
Eighty years after the post-war world economic order was established in 1944 at Bretton Woods with the dollar as the reserve currency, demand for the American currency remains high. This gives the USA great privileges: Americans are largely protected from exchange rate risks; the profit from money creation (seigniorage) increases; and the high demand for dollars leads to low interest rates and supports the dollar, which benefits purchasing power – whether at home or on vacation abroad.