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How US dollar dominance is built on America’s irresistible appeal to investors

  • The size of an economy is important but is not the only factor in a currency’s draw
  • If the yuan seeks to be the world’s reserve currency, China must offer a similarly attractive investing environment, with few capital controls, attractive yields and depth in bond market liquidity

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Given the size of the Chinese economy, the yuan might eventually be able to provide a realistic challenge to the US dollar, but creating an investing environment in China that has equivalent attributes to that of the US is a long way off. Photo illustration: Reuters
The share of US dollar reserves held by central banks dropped to its lowest level in 25 years in the final quarter of 2020 but the centrality of the greenback in the world financial system is unassailable.
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The renminbi’s profile is rising but it is not a viable challenger to a US dollar whose hegemonic status is cemented by the global financial system itself. The system’s requirements underpin the greenback’s dominant position.

The International Monetary Fund’s Currency Composition of Official Foreign Exchange Reserves (COFER) survey, published on March 31, showed that of the allocated reserves held by central banks, totalling some US$11.87 trillion, the US dollar’s share fell to 59 per cent in the fourth quarter of 2020. Yet the renminbi, despite the heft of the Chinese economy, still only accounted for 2.25 per cent of that total.

The renminbi’s share will undoubtedly rise, given the size of China’s economy and with Beijing taking measures to facilitate yuan internationalisation. But the Chinese currency won’t be challenging the US dollar any time soon because, in reality, more underpins the US dollar’s global dominance than just being the currency of – at least for now – the largest economy on Earth.

Containers are piled up at the Lianyungang Port Container Terminal in Jiangsu province, on March 24. The renminbi’s share of total forex reserves will undoubtedly rise in the coming years, given the size of China’s economy. Photo: AFP
Containers are piled up at the Lianyungang Port Container Terminal in Jiangsu province, on March 24. The renminbi’s share of total forex reserves will undoubtedly rise in the coming years, given the size of China’s economy. Photo: AFP
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That is not to deny that economic strength is a prerequisite for a dominant world currency. Indeed, the post-1945 hegemony of the US dollar derives from the United States being the only major economy that ended World War II with an undisrupted monetary system, a healthy trade surplus and a thriving industrial base that was undamaged by conflict.

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