US dollar strength persists despite long-foretold decline

November 12, 2024, 5:41 PM

Despite predictions, the US dollar has remained strong – it has gained against the yen, euro and pound in the past decade

US dollar is global trade currency
Most GCC states have dollar pegs
40% of cross-border payments

Since the end of the gold standard in the 1970s, financial industry observers have long predicted the US dollar’s demise as the preeminent global currency.

Yet 10 weeks from Donald Trump’s second inauguration as US president, the dollar still reigns supreme – at least for now.

This is despite periodic efforts by oil-exporting US rivals to sell crude in other currencies and the Federal Reserve’s quantitative easing programmes, which critics warned would debase the greenback.

For the six-country GCC and its largely expatriate workforce, the dollar’s ups and downs are of critical importance because of the region’s dollar pegs.

More broadly, the dollar is the main medium of exchange in international trade and the world’s de facto reserve currency. About 40 percent of cross-border payments made through the Swift international transaction system were in dollars in 2021, while about 50 percent of trade invoicing is in the US currency.

Joyce Chang, chair of global research at JP Morgan, said in a report last month that the dollar’s role in global finance is supported by deep and liquid capital markets, rule of law and predictable legal systems, a commitment to a free-floating regime and smooth functioning of the financial system.

Yet Chang also highlighted how energy sales are increasingly priced in other currencies. New cross-border payment systems that remove US banks from such transactions “could undermine the dollar’s clout”, she wrote.

The expansive policy of quantitative easing has not caused the dollar to fall in value, as per conventional economic theory, because central banks regulating other major fiat currencies also undertook massive QE programmes.

This decade the dollar is up 40 percent versus the Japanese yen, 5 percent against the euro and 1 percent on the British pound.

“The alternatives (to the dollar) are even worse,” says Omar Al-Ubaydli, president of the Bahraini Economists Society in Manama.

Al-Ubaydli said the euro-zone economy is “underperforming” while Japan’s economy is “struggling”.

“[Russia’s] rouble is under sanctions, so that leaves the Chinese yuan, but China’s economy is also facing significant challenges,” Al-Ubaydli says.

“There’s also reticence about using the yuan as a reserve currency in the same way as the dollar, because China’s monetary policy is much more of a black box than that of the US.”

“Black box” means the workings of the Chinese central bank are opaque, in contrast with the openness of the US Federal Reserve.

Non-Chinese citizens are, for example, not allowed to own the yuan at the domestic – more attractive – rate traded as the CNY. Citizens who can hold yuan are in theory subject to limits on transfers out of China. Foreigners must instead hold the CNH as traded in Hong Kong but offered at a worse rate to the domestic currency.

Ubaydli says the US’s “capricious use” of sanctions and China’s desire to decouple from Washington has led Beijing to move away from the dollar somewhat. But only somewhat.

In August 2024 China still held $775 billion of US treasuries, down 41 percent from a 2013 peak and representing 9 percent of total treasuries.

Francesco Pesole, a foreign exchange market strategist at ING in London, says China’s gradual de-dollarisation has been progressing for a while. “China is attempting to advance the notion that the yuan could become a global currency for financial transactions.” Pesole says. “For example, oil transactions, as well as a potential reserve currency.

“But currently the yuan and all other currencies fail to provide the same level of liquidity and financial market stability that the dollar offers. Were there to be another financial crisis, the dollar would remain a safe-haven asset.”