For the last decade, the U.S. dollar has reigned supreme as the world’s reserve currency. Central banks currently hold 63 percent of their foreign reserves in dollars. The euro comes in a distant second at 20 percent. The yen and the pound come next, at just under 5 percent each, trailed by the Canadian dollar’s 2 percent share.
Geopolitical change has many Wall Street strategists preparing for a rise in the euro’s reserve-currency status. As a result, they expect a trend of the euro rising in relation to the dollar. U.S. protectionism, the rising prospect of a U.S./China trade war, and evolving trade policies are expected to play roles in this trend.
Why the dollar has reigned supreme
For fifty years, central banks have seen the dollar as the safest reserve-currency option. The U.S. dollar provides stability like no other currency. America is the world’s largest economy. Its military is second to none. Since the dollar is backed by the most powerful government on earth, central banks know it has the depth to survive. While other currencies could wither very quickly in a crisis, the U.S. dollar can be expected to hold its value. On top of that, international oil sales are denominated in dollars, making the U.S. currency indispensable.
Why the euro lags behind
The euro came onto the world stage in 1999 with a bang. Many economists thought that the euro would provide a reserve-currency alternative to the dollar. By 2009, the euro’s share of world-currency reserves accelerated to 28 percent. Then, the global financial crisis sullied its luster.
The collapse of European economies like Greece, deflation, and turmoil within the EU made the euro unattractive to central bankers. As the European Central Bank lowered interest rates to near zero, reserve bankers has no incentive to hold euros, and it lost 30 percent against the dollar by 2016.
The euro is turning around
There is reason for optimism amongst euro bulls. The EU economy has picked up and anti-EU sentiment is falling. Many countries are looking to realign their reserve portfolios with more euros. While that by no means suggests the euro will replace the dollar as the world’s largest reserve currency anytime soon, it does suggest that the euro, currently trading at .80 to 1.00 U.S. dollar, has room to substantially rise in relation to the greenback.
The Donald signals a weaker dollar?
The U.S. President has made no secret of his belief that a cheaper dollar would help U.S. manufacturers become more competitive in the global marketplace. Boosting the U.S. manufacturing sector was one of his key campaign promises. Further, Trump has made clear he feels the U.S. can prevail in a trade war. His $60 billion in tariffs on Chinese goods show he is backing up words with action.
A cheaper dollar reduces the incentive for central banks to hold the U.S. dollar as their reserve currencies. The final outcome of a trade war is far from certain, of course, but a rebalancing or reserve currency holdings seems probable. Many countries may change in some of their dollars for euros.
Trade deal impacts
In the wake of what many call President Trump’s protectionist rhetoric and policy, Europe has ratcheted up its efforts to boost international trade, with many European countries cozying up to China, Japan, and much of Latin America. Data shows that the EU’s trade with China has increased by 75 percent in the past decade. The EU’s China trading volume has gotten close to matching America’s. With such trade partnerships flourishing, the euro’s value on the international market is likely to rise.