US dollar dominance wanes as CBDCs step into global spotlight


The COFER (Monetary Composition of Official Foreign Exchange Reserves) report recently released by the International Monetary Fund suggests that global finance may be on the cusp of a paradigm shift against the US dollar. With the rise of rival currencies such as the euro and Chinese yuan on the verge of going digital, the dominance of the USD could decline further in the coming years, analysts say.

However, central bank digital currencies (CBDCs) must compete with two hurdles in order to successfully challenge the USD: the rivalry of private cryptocurrencies as stores of value against inflation and regulatory uncertainty regarding the setting. artwork.

New lows for the dollar

In the fourth quarter of 2020, global U.S. dollar reserves fell to a 25-year record low of 59 percent, according to the IMF Report. The US dollar last fell below 60% in 1995.

“Some analysts believe this in part reflects the declining role of the US dollar in the global economy, in the face of competition from other currencies used by central banks for international transactions,” the IMF explained in a blog post. “If changes in central bank reserves are large enough, they can affect the currency and bond markets.”

Although the US dollar remains the dominant reserve currency in the world, the downtrend makes many people wonder what caused it and if its position will continue to erode.

Some cite a combination of countries abandoning the US dollar and the growing status of competing currencies like the euro, Japanese yen, and Chinese yuan as factors in the US dollar’s fall. But others say that even with China’s progress in developing a digital yuan, the hegemony of the US dollar faces no real rivalry – yet.

A changing financial landscape

“For the digital yuan to emerge as a serious competitor to the USD or even the euro, Chinese regulators would need to change their policy to allow the RMB to float freely in global currency markets. And no one sees this happening in the near future ”, Andrew Work, co-founder and director of the Lion rock institute in Hong Kong, says Forkast. News in an email.

But that could be a different story in Asia and among countries that view China as a key trading partner.

“The ability to see, track and retract the digital yuan can give [China’s central bank] more confidence to allow a little more to flow into neighboring client economies like Cambodia and Laos and move the use of the USD there. The Philippines can also be a target for local currency and US dollar displacement, ”Work said. “While other jurisdictions may restrict the use of the digital yuan, these countries would find it difficult to say no, even at the risk of their own currency becoming a second-tier player on their own borders.”

While digital currencies are unlikely to tarnish the dollar’s luster in global markets anytime soon, analysts say IMF report may indicate a slow move in the USD as major players begin to select alternative assets for their reserve baskets.

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Source: IMF

Against other reserve currencies, the dominance of the US dollar continued to decline in 2020.

Countries seek to break out of dollar dominance and enter Chinese euro and yuan

Russia and China have both moved away from an uncertain and politically entangled US dollar in recent years, with the Central Bank of Russia (CBR) giving up more than US $ 101 billion in dollar-denominated reserves in early 2019, and the release of data earlier this year revealing that it had more gold than usd on reserves in June 2020. Some have cited American sanctions against the nation after its annexation of Crimea as the reason for dropping the dollar.

In September 2021, assets denominated in dollars represented around 20% of total Russian holdings. This is a decrease from 50% in 2017.

China, for its part, has loosened its grip on US government securities, with a 20% decline in holdings over about seven years, according to data from the US Treasury Department. SMBC Nikko Securities senior economist Kota Hirayama told Nikkei Asia of Japan: “Most of the holdings of the Chinese Treasury are part of its foreign exchange reserves.”

While Russia’s holding of gold against the dollar may not be typical of central banks around the world, the IMF report shows popular currencies as reserve assets with the central bank. of Russia – like the yuan and the euro – are increasingly favorable globally.

A step towards digital domination?

According to the IMF report, both the euro and the Chinese yuan saw their small share of the US $ 12.7 trillion foreign exchange reserve pie grow. The share of the euro increased by 21% between the first quarter of 2016 and the fourth quarter of 2020, and the yuan exceeded 2% of world reserves at the end of 2020.

Other currencies like the Japanese yen – which topped 6% of global reserves for the first time in 20 years – are also on the rise. What’s unique about the yuan, and to a lesser extent the euro, is that they are moving to digital currencies – which could make them much easier to use in the future compared to a system. based on the US dollar in commerce and the like. cross-border transactions.

See the related article: 5 US digital dollar pilot projects launched to oust CBDC leader in China

The issue by the European Investment Bank (EIB) on April 28 of a blockchain-based issue is one example. CBDC digital bonds. Carried out in partnership with the Banque de France, the issue was described as “an experiment on the use of the digital currency of the Central Bank (CBDC) for the settlement of digital bonds issued by the EIB on a blockchain”.

The total value of the bonds was 100 million euros (approximately US $ 121.6 million). Societe Generale, Santander and Goldman Sachs also participated in the Ethereum-based project.

For the yuan’s share, China has been the pioneer among the leading countries in the development of a central bank digital currency. Already seven years in the making, the Chinese digital yuan – officially known as e-CNY but still colloquially referred to by its old name, DCEP (“Digital Currency, Electronic Payments”) – has yet to be launched. But the People’s Bank of China has already set up a working prototype, executed several pilot projects, and tested the digital yuan over the past year with banks, retailers and millions of citizen users.

Competing digital currencies – for citizens, banks, or both?

“These ‘govcoins’ are a new embodiment of money. They promise to improve the way finance works, but also to transfer power from individuals to the state, ”he notes. The Economist in a recent article on “the rise of electronic money. “

As some private sector cryptocurrencies such as Bitcoin are capped, non-inflationary, and decentralized in distribution and development, they could compete with digital fiat as stores of value.

“Many investors believe that all of these monetary and fiscal stimulus are going to weaken fiat currencies, so cryptocurrencies – especially coins like Bitcoin which have limited supply – are attractive as hedges against inflation,” said Frances Coppola, author of “The Case for People’s Quantitative Easing,” said Bloomberg Last year. “A lot of the strength of Bitcoin lies in the fact that fiat money is plentiful and unrewarding.”

European Central Bank President Christine Lagarde summed up the growing apprehension of regulators in March: “Central banks must keep pace with the rapid pace of innovation, if they are to ensure that money stays healthy, that payments are efficient and the financial system is stable. “

the Economist the article notes that central banks fear losing control of a private asset that has become increasingly important in financial markets. “Bitcoin has grown from an obsession with anarchists to a $ 1 billion asset class that many fund managers insist belongs in any balanced portfolio.”

CBDC ddevelopment continues, but the United States is cold-eyed

Despite the controversy over the pros and cons of CBDCs, governments around the world are increasingly exploring, researching or testing the implementation of digital and programmable fiat. The eight central banks of major currencies in the IMF report are actively considering, researching or developing a CBDC.

In the United States, however, despite private sector advocacy and research on a digital dollar, a government-backed digital currency still looks a long way off.

U.S. government officials have repeatedly expressed coldness about the idea of ​​a digital dollar and did not want to rush to recreate the existing U.S. monetary system.

As Federal Reserve Chairman Jerome Powell noted in March: “We have a two tier system: central banks interact with banks, banks interact with the public. And we don’t want to destabilize that.

According to the work of the Lion Rock Institute, it’s not clear that an American CBDC would pay many dividends – at least when it comes to public opinion.

“It’s hard for the general public to see the difference between a CBDC (like the digital yuan) and a well-functioning digital payment processing system, so there’s no reason they prefer a Reserve CBDC.” federal level M0 compared to current options. “

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Powell also suggests that the CBDC that will likely launch in China may not work well in the democratic United States, whose citizens respect privacy.

“The currency used in China [digital yuan] isn’t the one that would work here, Powell said at a press conference last month. “It’s the one that really allows the government to see every payment used that it’s being used for in real time.”

Powell has repeatedly stressed that there is no need for the United States to rush into a CBDC, citing the status of the USD as a global reserve currency.

But if the trends noted by the IMF continue, the US Federal Reserve may not have as much time as it thinks to remain competitive in a rapidly changing financial landscape.

“America should watch China for now and not lose sleep,” said Work of the Lion Rock Institute. “Cambodia and Laos should prepare for the end of the riel and the kip if they do not intend to actively resist such a fate.”


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