The latest official currency composition of foreign exchange reserves (COFER) data released by the International Monetary Fund (IMF) recently showed that

the global dollar-denominated foreign exchange reserves in the fourth quarter of 2021 were US$7.087 trillion, and the market share further declined from 59.15% in the third quarter to 58.81%, the lowest since 1996.

  To a certain extent, this reflects that other currencies, gold and other assets are competing with the US dollar, so that the role of the latter in the global economy is weakening.

  The IMF pointed out that in recent years, global central banks have been slowly advancing the adjustment of the foreign exchange reserve structure.

The dollar's share of global reserves will continue to decline as central banks in emerging market and developing economies seek to further diversify their reserve currency composition.

Inflation and debt are hidden dangers

  By IMF standards, dollar-denominated foreign reserves include U.S. Treasuries, U.S. corporate bonds, U.S. mortgage-backed securities and other dollar-denominated assets held by foreign central banks.

  After the establishment of the Bretton Woods Agreement in 1944, the US dollar was directly linked to gold and gradually replaced the British pound as an international reserve currency.

In 1971, the then US President Nixon announced that the US dollar would no longer be pegged to gold, the Bretton Woods system collapsed, and the global monetary system entered the era of sovereign credit currency.

Nonetheless, the dollar subsequently remained the world's number one reserve currency.

  Historically, inflation has often had a shock to dollar-denominated foreign exchange reserves.

According to Wolf Street statistics, the dollar’s ​​share of global foreign exchange reserves peaked at 85% in 1977 before U.S. inflation soared.

Subsequently, the domestic price level in the United States rose rapidly. Expansionary fiscal and monetary policies did not bring market vitality, but instead increased inflation. Since the Federal Reserve did not take measures at that time, countries began to sell dollar-denominated assets, resulting in a rapid decline in the dollar’s ​​market share.

The U.S. economy experienced a period of stagflation in the 1980s after then-Fed Chairman Volcker decided to take tough measures and launched two rounds of interest rate hikes, and the market share of the U.S. dollar in foreign exchange reserves continued to decline until bottoming out in 1991.

  Now the United States is facing a similar dilemma. The

latest data shows that the US consumer price index (CPI) in February increased by 7.9% year-on-year, hitting a 40-year high

.

The Federal Reserve restarted its rate-raising cycle last month in an effort to curb price inflation, and may begin shrinking its balance sheet in May.

Debt issues also deserve attention.

At present, U.S. government bonds are still one of the safest assets in the world, and a large part of the foreign exchange reserves of various countries exists in the form of holding U.S. bonds.

For decades, the United States has enjoyed the benefits of the dollar as the world's reserve currency, regardless of having to prop it up to avoid default.

On the other hand, driven by the loose fiscal policy of the US government, the overall debt level continued to rise.

The latest data show that the US public debt has exceeded 30 trillion US dollars, at the same time, the scale of the trade deficit is also expanding.

  A new cycle of rate hikes will lead to a rapid rise in borrowing costs under huge debts.

U.S. President Biden signed the Continuing Resolution Act in March this year to prevent a government shutdown. The U.S. Treasury Department’s borrowing authorization was extended until 2023, temporarily avoiding government debt defaults, but did not resolve substantive issues.

It is estimated that by the end of this year, the size of the US federal government's debt will be close to 31 trillion US dollars, and the debt ceiling issue will continue to be a bargaining chip in the bipartisan game of Congress.

  Debt defaults have significant implications for reserve currency status.

The French franc lost its reserve currency status in the 1960s as the French government struggled to cope with a wave of independence in places like Algeria, leading to a rapid deterioration in the country’s finances, Cointdesk reports.

Today, many people have begun to worry that the United States will not be able to repay the huge debt that continues to expand rapidly.

Renminbi assets become more attractive

  According to IMF data, the share of the renminbi in the global reserve currency reached 2.8% in the fourth quarter of last year, an increase of 0.9 percentage points in two years, further widening the gap with the Australian dollar, Swiss franc and Canadian dollar, and the attractiveness of the asset has gradually increased.

The first financial reporter noticed that the international reserves management report released by the Central Bank of Brazil on March 31 showed that the share of the RMB in Brazil’s foreign exchange reserves in 2021 will rise from 1.21% in the previous year to 4.99%, marking the first time that the RMB will enter the country in 2019. The highest level since the currency basket.

  In October 2016, the IMF included the renminbi in a basket of currencies backing the Special Drawing Rights (SDR).

At the end of March 2017, the IMF first announced the data included in the RMB-denominated reserves, which fully affirmed China's reform of the market economy and the continuous internationalization of the RMB.

  At present, the currency composition of the IMF's official foreign exchange reserves (COFER) mainly includes the eight major currencies of the US dollar, the euro, the Japanese yen, the British pound, the Chinese yuan, the Canadian dollar, the Australian dollar and the Swiss franc.

  As the biggest competitor of the US dollar since the 21st century, the euro has slumped after the European debt crisis, and its share in the global reserve currency has remained at around 20%.

Although the dream of "competing against the US dollar" has not been realized, it can still sit firmly on the top spot of the second largest reserve currency.

  The third largest reserve currency is the Japanese yen, whose market share has soared since 2015, reaching 6.0% in the fourth quarter of 2020, and then began to gradually decline, the latest data is 5.57%, down 23 basis points from the previous quarter.

Sterling has been largely flat over the past few years and Brexit has not had a significant impact on market demand for the pound, with a market share of 4.78% making it the fourth largest IMF reserve currency.

De-dollarization and Reserve Status Challenges

  Looking back on history, it is not uncommon for the United States to use the US dollar as a financial weapon. The precise targeting of financial and trade systems through sanctions has caused many countries to suffer, such as Iran in 2011 and Venezuela in 2016.

In extreme cases, the U.S. could cut the dollar off from other central banks, isolating the country’s economy.

Raghuram Rajan, the former governor of India's central bank, called this power an "economic weapon of mass destruction."

In the Ukraine crisis, the issue of the "weaponization" of the dollar has attracted renewed attention. The United States froze more than $630 billion of Russia's foreign exchange reserves and hit the ruble's exchange rate for a while.

  When financial weapons are frequently used, many countries begin to consider switching from the US dollar to other currencies.

Bank of America strategist Michael Hartnett said the "weaponization" of the dollar could lead to a weaker dollar.

The "Balkanization" of the global financial system has diminished the role of the United States as a reserve currency.

  The weight of the U.S. dollar in global trade has also gradually declined in recent years, a trend that is likely to continue as Russian banks are removed from the SWIFT system.

The United Kingdom, France and Germany established the "Instrument of Support for Trade and Exchange" (INSTEX) mechanism in early 2019 to maintain the channel for trade with Iran.

Russia and Turkey have reached a bilateral energy trade agreement in their local currency, and crude oil trade between the euro area and Norway is settled in euros.

The emerging Asian economies Indonesia, Malaysia and Thailand have previously announced that they will adopt non-US dollar currencies or local currency transactions in the trade settlement of the three countries.

  Foreign media believe that despite signs that demand for reserves is declining, it will not be easy to replace the dollar as the world's preferred reserve currency.

About 40 percent of global trade transactions use the U.S. dollar, while 80 percent of global cross-border transactions use the U.S. dollar, according to Federal Reserve data.

As a rising variety, the renminbi has received widespread attention, but its share of less than 3% means that there is still a long way to go in the future.

Another benefit of holding U.S. currency reserves is that the U.S. market is significantly more liquid and deep than other markets.

The $23 trillion market for U.S. Treasuries is more than twice the size of the Japanese government bond market, and in Europe, the U.K., Germany, Italy and France all have less than $3 trillion in government bond markets.

  The IMF noted that despite the major structural shifts in the international monetary system over the past 60 years, the U.S. dollar remains the dominant international reserve currency.

In the long run, though, any change in the status of the dollar could come.