Dollar’s status as reserve currency to endure

Investing.com – A move by US authorities to seize Russian assets could add to recent efforts to diversify away from the dollar, but the dollar is likely to remain the global reserve currency for the foreseeable future, according to Wells Fargo.

Is the dollar's role as a reserve currency in question?

The United States and its allies blocked transactions with the Russian Central Bank and the Russian Ministry of Finance and froze about $300 billion in sovereign Russian assets in the West, following the Russian invasion of Ukraine.

To intensify the potential punishment, the US House of Representatives passed a bill late last month that allows the Biden administration to confiscate these Russian assets located in US banks and transfer them to Ukraine.

Such action would likely trigger retaliation, as Dmitry Medvedev, a close ally of President Vladimir Putin and deputy head of Russia's Security Council, has said that Russia may respond to any US seizure of its currency reserves by seizing assets, including property and money. Cash for US citizens.

This will have a very limited impact on the dollar in its role as a counter currency, but is likely to attract the attention of China given the Asian giant's physical exposure to the US dollar.

Concerns about the US fiscal outlook and the continued use of economic sanctions by Washington have already brought the dollar's role as a global reserve currency into question in some capitals. Adding the risk of asset forfeiture can reinforce this thinking.

“In theory, geopolitical tensions between the U.S. and China should prompt China to make a concerted effort to move away from the dollar and other advanced economy assets,” Wells Fargo analysts said in a May 3 note.

Moves to reduce the importance of the dollar

There have actually been some moves over the years to try to downplay the importance of the dollar.

These included developments such as Brazil and China announcing clearing arrangements in their respective currencies, and the willingness of energy-exporting Middle Eastern countries to accept them as payment, as well as a possible common currency for the BRICS countries.

However, Wells Fargo has downplayed the significance of these moves.

The US bank noted that trade relations between China and Brazil are worth only about 0.40% of total global trade, which is far from being material enough to cause a noticeable decline in the dollar.

“We also had doubts that Middle Eastern energy exporters, most of which operate under a fixed US dollar exchange rate regime, would be willing to jeopardize currency pegs by generating lower dollar revenues,” Wells Fargo analysts said. The BRICS common currency is unlikely to gain momentum in our view.

The dollar was put on hold as the reserve currency

Wells Fargo said to be considered a “reserve currency” it must exhibit certain characteristics, including being freely convertible, widely accepted, used in global trade and transactions, and backed by large, liquid debt markets that are easily accessible to foreign investors and not subject to controls. Political influence, i.e. linked to an independent central bank.

The US dollar checks all of these elements, and while other currencies are also associated with these characteristics, Wells Fargo believes there are issues that will prevent the dollar from losing ground.

The euro and pound are freely convertible, unpegged, and not subject to capital controls, but government debt markets are not as deep as in the United States, and the risks of fragmentation in the eurozone could give foreign exchange reserve managers pause for thought.

The Japanese government bond market has been, and continues to be, heavily distorted by the Bank of Japan, and Chinese government bonds, capital controls, and convertibility concerns, as well as the RMB's managed exchange rate regime, should be a disincentive for managers to allocate reserves. Currency holdings towards Chinese assets.

“Taking these factors into account, we see limited alternatives for foreign exchange reserve managers to US government bonds and, therefore, see the US dollar’s ​​status as a global reserve currency as secure for the foreseeable future,” Wells Fargo added.

Morgan Stanley agrees, saying that the influence of the dollar in the global economy across a range of economic and financial metrics remains strong, and therefore the search for an alternative is a difficult task.

“The most discussed competitor is China, and we expect a more modest global role for the Chinese yuan,” analysts at Morgan Stanley said in a note last month.

“But we believe China's three-pronged challenge of debt, deflation and demographics will limit the Chinese yuan's international appeal,” MS added, estimating that yuan currency reserves should rise to just 5% in 2030 from 2.3% now.

“We expect only a moderate and gradual decline in the international use of the US dollar, given rising multipolarity and continuing low diversification costs for reserve managers.”