What a Loss of Dollar Dominance Might Mean for Asset Prices

The U.S. remains the world’s leading economy and military power, but the rise of China could usher in the fall of the dollar’s dominance.

Reserve currencies are foreign exchange instruments held significantly by central banks, governments, monetary authorities and supranational institutions as part of their foreign currency reserves. Reserve currencies are critical for cross-border international transactions, international investments and all aspects of the global economy. Since the end of World War II, the U.S. dollar has been the leading global reserve currency. France held the world reserve currency from 1720 to 1815, and Britain took over from 1815 to 1920.

The U.S. created the Federal Reserve System in late 1913 and emerged as the supreme power after the First World War. Today, reserve currency status reflects the faith and credit of the government issuing the legal tender.

The U.S. remains the world’s leading economy and military power, but China is nipping at its heels, and the rise of China could usher in the fall of the dollar’s dominance. The demise of the U.S. dollar will not happen overnight, but the writing is on the wall, and it could significantly impact markets across all asset classes.

The economic and geopolitical landscape has changed: Money is power

• China and Russia’s “no-limits” alliance, Russia’s invasion of Ukraine, and Chinese designs on reunification with Taiwan created a bifurcation of the world’s nuclear powers.
• The U.S. debt ceiling standoff threatens a default that would significantly impact the U.S. credit rating and roil markets across all asset classes.
• The ascent of U.S. interest rates that rose from zero in March 2022 to over 5% in May 2023 caused bank failures that threatened credit and other markets, increasing the potential for a recession.
• The events weigh on the U.S. currency’s value and powerful position as the world’s reserve currency.

The dollar index experienced a blow-off high

• Rising U.S. interest rates pushed the U.S. dollar index to a two-decade 114.745 high in September 2022.
• The index declined to the 102.50 level on May 12 as the trajectory of rate hikes slowed, debt issues faced the U.S., and the potential for a recession increased.
• The dollar index only measures the U.S. currency against the euro, pound, yen, Canadian dollar, Swedish krona, and Swiss franc. The greenback has declined against the other freely convertible world foreign exchange instruments.

The index is a mirage: China is aiming to replace the dollar

• China, Russia, and other BRIC countries are critical for world trade as they produce and consume raw materials.
• China is the world’s leading commodity producer and consumer, with the second-leading economy, gaining ground on the U.S.
• Geopolitical bifurcation has led China to negotiate trade agreements for payment in yuan and other non-dollar assets. Saudi Arabia is considering accepting yuan instead of dollars for Chinese crude oil purchases.
• Chinese leader Xi told Russian President Putin, “Change is coming that hasn’t happened in 100 years, and we are driving this change together.”
• China and Russia are working to surpass the U.S. politically and economically by lowering the dollar’s profile in the global financial system.

As the dollar falls, stocks and bonds will suffer

• As the U.S. currency loses ground as the world’s reserve currency, inflation will rise, with U.S. stocks and bonds losing their attraction.
• Elon Musk recently blamed U.S. policy on the dollar’s decline, saying, “If you weaponize currency enough times, other countries will stop using it.”
• Stocks and bonds have historically moved higher when the dollar declined, but that could change if the dollar loses ground as the world’s reserve currency.
• S. debt at $31.7 trillion and rising by more than $1.6 trillion annually as a function of short-term interest rates at over 5% is unsustainable.

Commodities and inflation could soar if the dollar takes a back seat to the yuan or another world exchange instrument

• Gold flashed a warning sign with a post-May FOMC rate hike rally to a new high of $2,085.40 per ounce on the nearby June COMEX futures contract.
• Central banks have been buying record amounts of gold, adding to reserves. Gold is an inflation barometer.
• The yuan may not replace the dollar as the world’s reserve currency because it is not convertible, but the dollar could still lose ground.
• Twenty-four countries could accept a Chinese-led BRICS currency that would challenge the U.S. dollar for cross-border transactions and reserve currency status.
• A weakening dollar that loses its position is inflationary and supports higher raw material prices and Goldman Sachs’s forecast of a “Commodity Supercycle.”