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The Value of the Greenback

The U.S. dollar, or “greenback” in slang, is the reserve currency for the world and has been for over 60 years. However, what does being a reserve currency mean?  

To avoid exchange rate risk (different currencies moving in the wrong direction during a trade), countries’ central banks hold the same currency to use for trade. Back when the dollar was pegged to gold, other currencies were pegged to the dollar. When it became clear that the British pound sterling was fading from prominence and a change to reserve currency was needed, the U.S. dollar became the currency of choice. Today, most trade is done in U.S. dollars, which gives the U.S. an advantage. Being the reserve currency around the world leads to demand for the U.S. dollars and increased economic power and influence, as well as reduced exchange rate risk.

Since the end of World War II, the dollar has been involved in about 90% of annual global transactions. In the most recent quarter, the International Monetary Fund (IMF) puts U.S. dollars at 58.4% of currency reserves, euros at 20.5% and the yen at 5.5%.  

Recently, China has been working on trade agreements that eliminate the U.S. dollar as a go-between. This year, Brazil and China signed a deal to use their own currencies, and China is in talks with Saudi Arabia to do the same when buying oil. While China’s yen was only 2.7% of annual global trade dollars, China fixes its currency in a 2% range around the U.S. dollar.  China would need to go a long way to replace the U.S. dollar as a reserve currency.

The U.S. dollar is a free-floating currency, which means the value against other currencies will be determined by market forces of demand and supply. For the last decade, our currency has been on the upswing and recently hit a 20-year high. However, since September 2022 the dollar has fallen 8.6% from its peak. This is due to the concerns over our banking system. We have had three banks fail so far in 2023. The total assets of three banks— First Republic (FRC), Signature Bank (SBNY) and Silicon Valley Bank (SIVB)—  have exceeded the assets of the 25 banks that failed in 2008. With the Federal Reserve raising rates since last March, the concern for a recession is on everyone’s minds. With bank defaults and a recession looming, the dollar is reflecting some weakness in our economy. 

In addition, the debt-ceiling is causing stress to our system. Treasury Secretary Janet Yellen announced this week that the debt-ceiling deadline is closer than anticipated, less than a month away, June 1.  The biggest way to discredit a country, their economy and their currency is to default. For the United States, it would be an economic catastrophe. The debt limit is the total amount of money the United States government is authorized to borrow to meet its existing legal obligations, which includes interest on national debt, tax refunds and social security payments. If Democrats and Republicans don’t move forward with a debt ceiling increase before June 1, the payment of U.S. obligations is in doubt. This will hurt the dollar in the extreme and could lead to the dollar losing its place as the world’s reserve currency.

The value of the dollar and its stability matter a lot to our economy and international trade. Maintaining its integrity is of utmost importance to holding our top position in the world economy. Let’s be optimistic that we can unite on decisions as a country that conveys strength and stability.

Judy Loy is a Registered Investment Advisor, ChFC®, RICP® and CEO of Nestlerode & Loy, Inc. in State College.

All investing is subject to risk, including possible loss of the money you invest. Nothing in this article should be construed as investment or retirement advice.  Always consult with a professional advisor and consider your risk tolerance and time to invest when making investment decisions. Review your personal situation with a professional before planning any gifting or estate planning.