The Fed considered scenarios for reducing the dollar’s role as the world’s reserve currency. They will mainly depend on the decisions of China, India, and Saudi Arabia. The freezing of the Bank of Russia’s foreign exchange reserves has heightened fears of other governments that their dollar assets are not perfectly safe.
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Scenarios of the dollar’s decline as the world’s reserve currency
Federal Reserve economist Colin Wise, based on confidential data, considered scenarios for the decline of the dollar’s role as the world’s currency due to geopolitical factors.
In his study, Wise admits the dependence of the value of reserves in dollars on using this currency in international payments. At the same time, the transition to settlements between countries in national and other currencies other than the dollar is expected to reduce the dollar reserves of the country.
Transition to settlements in yuan between developing countries in Africa, Central Asia, Latin America, and the Middle East (43 countries). Such a scenario would reduce the share of the dollar by 6.2%.
Transition to settlements in yuan between 43 countries, as well as China and Hong Kong. This scenario would reduce the dollar’s share by 10%.
A long-term scenario of reduction of the dollar in export settlements would reduce the share of the dollar by 11.8-17%. Saudi Arabia, India, China, and Brazil would make the largest contributions.
Even in the latter scenario, the dollar will have an important role – its share will still exceed that of other currencies by a factor of two or more, says Wise. He stresses that he believes that scenarios of a widespread abandonment of the dollar motivated by geopolitics are unlikely.
For the proposed scenarios to materialize, several fundamental changes would have to take place: for example, China would need to give up its control over capital flows, and Saudi Arabia would need to give up its currency peg to the dollar.
According to the IMF, foreign reserves in dollars stood at 59.5 percent of the total at the end of the second quarter of 2022, up from 66 percent in 2015 and 71 percent in 1999.
In the medium term, the role of the U.S. dollar in the financial system will decline due to the acceleration of processes of dedollarization in the countries of the world, reduction of reserves, expansion of using digital national currencies – thus there will be “updating of the architecture of the system”.