The Dollar System Threatened by Weakening Trust

If the United States ceases to be perceived as a reliable guarantor of stability and security, the incentive to trade in dollars and reinvest them in the U.S. market decreases. Similarly, as oil prices normalize and importers recover, they will have a surplus of dollars to reinvest in the United States. However, this can no longer be taken for granted. Therefore, it is difficult to refute that the real demand for dollars has weakened considerably. The market has returned to the ancient solution of gold as a flawless global guarantee—at the expense of the U.S. currency—amid growing distrust in the dollar standard and the lack of viable alternatives to assets outside the financial system. We can observe this in the changing behavior of global central banks. The dollar system is also pressured by rising energy prices and ongoing supply constraints. Oil and gas prices have dropped significantly after the ceasefire announcement but remain much higher than before the war. The dollar cycle, which has underpinned the global monetary system, is under increasing pressure. As already stated, this is not a phenomenon that arises overnight. However, if we consider the adjusted value of dollar reserves as the "weight" of the currency, it has fallen by 15% since official U.S. dollar reserves peaked around 2014. World trade in dollars has fallen to around 40% in recent years, while that of euros and yuan has increased; international loans denominated in dollars have retreated to 60% of the world total; central banks' holdings of Treasury bonds are now lower than their holdings of gold; and the dollar's share in central banks' global currency and gold holdings is rapidly declining. Often, common knowledge is all that is needed to change established norms and subvert entrenched patterns of thinking. First, in the case of Middle Eastern exporters, like Saudi Arabia, they have fewer surplus savings to recycle, as their economies diversify and invest more domestically. But the situation is even more critical. The exchange that constitutes the basis of the global monetary system—that the income from trade is recycled into dollar assets, allowing the U.S. to finance itself at low cost, in exchange for security guarantees and the stability of the global system—can no longer be taken for granted. Normally, one would expect that once the Strait of Hormuz is fully reopened, dollars would flow back to oil exporters, who in turn would buy Treasury bonds or other U.S. assets. Until the seizure of Russian assets, they operated opportunistically with the dollar, buying it when the currency fell and selling it after it recovered. A more equitable comparison is made with the dollar without considering its interest-generating effect, as shown in the chart above. Unadjusted dollar reserves then amount to about $4 trillion, barely half of the $7.5 trillion unadjusted figure published by the IMF, which includes the interest generated (I use the Bloomberg US Treasury index and subtract its yield from the unadjusted figure). No longer is the case. The depreciation of the dollar in recent years has not translated into significant purchases. But it goes beyond changing central bank preferences. Following the United States' unilateral actions in the Iran war, everyone now knows that the rules of the game have changed. It is increasingly logical to own fewer dollar assets. The U.S. war with Iran has exerted a potentially irreversible pressure on the global trading system, and gold reserves have for the first time in several decades surpassed central banks' valuation-adjusted dollar asset holdings. It is still very early after the announcement of a ceasefire between the U.S. and Iran, but even if it holds, the conflict is likely to have had lasting effects on the dollar system, as President Donald Trump appears to be dismantling the rules-based order in place since World War II. The fall of the dollar has been greatly exaggerated on numerous occasions. The current lack of reserves and alternative sources of financing guarantees it, but that does not mean there is no problem and that the system is not losing liquidity. The rise of gold is just a warning signal, but others are being heard more strongly. Overall, this dynamic caused gold and Treasury bonds to rise when tensions eased, and vice versa. However, there is a much deeper and more lasting problem. This is exerting greater pressure on energy importers to obtain dollars by liquidating assets. Additionally, energy exporters who have not been able to sell their product have been facing liquidity problems. Now that this is public knowledge, it is hard not to foresee that the dollar's dominance will continue to diminish over time, while gold's fortune will recover even more. Simon White is a macro-strategist who writes for Bloomberg. The amount published by the IMF is real, but it does not reflect active demand. The same argument can be applied to gold. Instead, central banks (almost exclusively from emerging markets) have increased their physical holdings of bullion, in tons, by 15%. Central bank reserves may be passively benefiting from the historic rise in the metal in recent years. However, it will not be a one-off and dramatic event. The observations he makes are his own and are not intended as investment advice. The decline of the British pound as a reserve currency was marked by several milestones over an extensive period: the end of World War I, the abandonment of the gold standard, the Bretton Woods negotiations, and the Suez crisis. Following the increasing instrumentalization of the dollar as a weapon, which culminated in the seizure of Russian assets following the war in Ukraine and the proposal of a deal at Mar-a-Lago, the U.S. currency has just passed another milestone in its waning dominance. Dollar-denominated reserves—that is, central bank holdings—adjusted for valuation effects, are now below gold reserves for the first time since the IMF began publishing these data in the late 1990s. Comparing the unadjusted value of the dollar with that of gold, as is often done, is not a fair comparison, as the precious metal does not generate interest.