Throughout history, global reserve currencies have emerged and declined, following characteristic lifecycle stages due to a combination of geopolitical, economic, and technological factors. The four stages of a global reserve currency’s life cycle are: emergence, expansion, peak, and decline. In this essay, we will review the essence of each phase and conclude by analyzing where the US dollar is currently.
Emergence:
The emergence of a currency as a global reserve currency is often coincided with the geopolitical and economic prowess of the issuing country. Global reserve status makes it attractive to other countries, and they, in turn, start using it as a store of value and a medium of exchange. The emergence of a reserve currency enhances the issuer country's ability to finance its soil- domestic and global debt obligations. Throughout history, a variety of currencies have played this role, starting from the silver drachma of ancient Athens through the Gold Standard using British pound Sterling, the Bretton Woods system with the US dollar, to currently the US dollar.
Expansion:
At this stage, the reserve currency's use becomes more widespread. More countries start using it for international trade, and central banks increase their holdings of the currency. The globalization of trade and finance provides a tailwind to the currency that becomes a highly liquid and convenient asset that facilitates transactions worldwide while also providing a stable store of value. The demand for the currency continues to escalate as more countries develop their economic links, and multinational corporations denominating transactions in the reserve currency strengthen its advantage. The US dollar's expansion accelerated after the Bretton Woods accord, which led to an explosion in US dollar reserves in central banks worldwide.
Peak:
At this stage, the currency reaches its zenith as far as global reserve status is concerned. Its use becomes deeply embedded in the global financial system, as the majority of international transactions are conducted with it. At the peak, the issuing country enjoys significant macroeconomic benefits that come with the reserve currency status, as it becomes the currency of choice for commodity pricing, credit markets, and liquidity provision to other countries. The peak status of US dollar as a global reserve currency came after the collapse of the Soviet Union, which led to its use for oil invoicing and the fall of the Berlin wall, which facilitated the global expansion of trade and finance.
Decline:
At this stage, the currency starts losing its global reserve status either due to a decline in geopolitical influence or economic factors such as inflation, debt, and trade deficits. The loss of this status can lead to abrupt changes in currency exchange rates, lower global demand for the currency, and a threat to the issuing country's sovereign credit rating, which can lead to significant financial and economic instability. Prior to the US dollar, the French franc and pound Sterling played this role throughout history.
As of today, the US dollar is still the world's reserve currency, accounting for more than 60% of the world's foreign exchange reserves. The United States' political power, military and economic strength continues to support its global reserve currency status. However, the US dollar is currently facing significant challenges to maintain its status, including increasing US debt levels, a trade deficit, and inflation, uncertainties due to the Covid-19 pandemic, and the rise of China's economic and geopolitical influence. Some experts predict that the Chinese Yuan may become a global reserve currency in the coming years, potentially challenging the dominance of the US dollar.
To summarize, the US dollar is currently in the peak to decline transition stage of its lifecycle as a global reserve currency. While it still enjoys significant global reserve currency demand, it is facing increasing macroeconomic and geopolitical headwinds that could challenge its status in the near term.