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Mar 30, 2017 | 20:50 GMT

3 mins read

Which Currency Could Replace the Dollar?

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Which Currency Could Replace the Dollar?

Since the recent change of leadership in the White House, questions have arisen about the sustainability of the dollar's role as the global reserve currency. Some of U.S. President Donald Trump's previously stated positions, if they come into being, would likely undermine faith in the currency. Investors should therefore take seriously the possibility that the dollar could become a less secure asset in the years to come. Of course, focusing on the dollar alone doesn't tell the whole story. Investors would also have to consider what alternative to move into. And at the moment, there are few contenders that could be considered reliable successors to the dollar.

The euro is the second reserve currency after the dollar. When the eurozone was created in 1999, some experts predicted that the euro would overtake the dollar by 2015. Since then, however, the divisions among European countries have become ever clearer. Unless the monetary union also becomes a fiscal union with risk-sharing  — an unlikely proposition — investors will be reluctant to put their faith in the euro for fear that the currency bloc could collapse at any moment.

The Japanese yen would be third in line in its suitability to assume global reserve status. During Japan's period of rapid growth in the 1970s and 1980s, its leaders chose to adopt the shield strategy and did not promote the yen's internationalization, even though many in the United States regarded it as a threat. Today, with the country in a prolonged economic slump and the demographics of its aging population working against it, it is hard to see the yen mounting a challenge for the top spot any time soon.

Much has been written in recent years about the rise of China and its currency, the yuan. In some ways, China has made great strides in internationalizing its currency. Currency swap lines and entry into the International Monetary Fund's Special Drawing Right (SDR) basket show that the Chinese have been creating the infrastructure of a reserve currency for the yuan. But so far, few investors or traders have embraced it. In the foreign exchange market, the yuan accounts for only 1.7 percent of international payments in January 2017 (compared with 40.7 percent for the U.S. dollar). China faces problems largely connected with its political system: Investors are unlikely to allow the yuan to become the global reserve currency as long as China remains an autocracy, since the risk of political interference in its value would be high.

Some of the truths investors had taken for granted with regard to the dollar may no longer be relied upon, and the currency could become less secure in the future. Nevertheless, a look at the dollar's potential replacements shows that none are close to being ready to assume its mantle as the reserve currency, and in fact many are headed in the wrong direction.

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