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No Alternative to the USD as the World’s Reserve Currency

August 11, 2020 By Mircea Vasiu

The recent leg lower in the USD started polemics among traders and investors. Many voices began arguing that the USD’s role as the world’s reserve currency is in danger. 

After all, it dropped 10% against the Euro in less than four months. Is it so that the USD is poised to lose its influence? Unlikely.

USD Still Dominates World’s Financial Markets

Before going into details regarding the USD’s role in the world’s financial markets, one must understand what a reserve currency is. Sovereign nations with excess currency reserves have the option to build them in various currencies.

The USD is not the only reserve currency in the world. Nations also build reserves in EUR or GBP. However, the size of reserves in USD has dominated for the last several decades.

To fully understand the USD’s influence, here are some numbers to interpret. The global foreign exchange market reached $6.6 trillion in daily turnover.

Out of this staggering number, the USD is the most dominant currency. It sits on one side of 88% of all trades. In other words, in any transaction, there is a buyer and a seller. In 88% of the cases, one of them deals USD.

Moreover, a deeper look at the size of all other transactions reveals the role of other currencies in the overall global currency market. As such, the Euro comes next, with 32%, the Japanese Yen follows, with 17%, and the British Pound closes the list with 13% of the daily FX market turnover.

How about the emerging markets’ currencies? All emerging market currencies sum to 25% of the daily FX turnover. Finally, the Chinese Renminbi is the 8th most traded currency involved in 4% of all trades.

These numbers reflect the undeniable role of the USD in the international financial system. Moreover, when the EURUSD or any other currency pair signals a 10% drop in the USD, the drop does not refer to the entire share that the USD has in the global FX market.

For instance, it is true that the USD lost 10% against the EUR in the last four months. However, at the same time, it made new all-time highs against the Turkish Lira, for example. Also, other emerging markets’ currencies suffered the same fate.

Once again, before falling for alarmist headlines, a bit of research goes a long way. The USD is here to stay as the world’s reserve currency, as there is no substitute for it.

Yet.