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As the US dollar dwindles, the yuan gains attention

  • US dollar (USD) finishes at the bottom of the global currency heap
  • Euro (EUR) and Chinese yuan (CNY) biggest benefactors of US dollar (USD) weakness
  • Despite rising inflation, comments from the Federal Reserve dampen the greenback’s appeal
  • US dollar to Canadian dollar (USD/CAD) currency pair tumbles
  • Weaker-than-expected US April housing data could lift USD

The US dollar (USD) is the world’s reserve currency, meaning it is held in significant quantities by central and commercial banks across the globe.

Due to its status, the US dollar (USD) is a powerhouse in the foreign exchange market and the most widely used currency for international transactions.

Not only does the American dollar belong to the world’s largest economy, but it is the main currency in several other regions of the world, including the British Virgin Islands and Caicos Islands.

The United States overtook the British empire and became the world’s largest economy in 1890, with productivity fuelled by the Industrial Revolution.

According to the latest data from the World Bank, US gross domestic product (GDP) accounts for USD 21TN of the global economy, compared to China, the world’s second-largest economy, which produced USD 14TN of global output.

Britain’s share of global GDP was significantly lower at USD 2.82TN, while the European Union contributed approximately USD 15TN to world output.

However, there has been evidence that the greenback is losing its grip on global dominance in recent years, and the Chinese yuan (CNY) is emerging as a worthy contender.

But before we discuss whether the US dollar (USD) is in decline and other reserve currencies are “going big”, let’s look at the history of the greenback.

US Dollar

History of the United States Dollar

The United States Dollar (USD) was founded on the worth and appearance of the Spanish dollar, which circulated in Hispanic America between the 16th and 19th centuries.

History shows that the greenback was not established until 1792, albeit it wasn’t the US dollar (USD) as we know it today, but coins similar in scale and shape to the Spanish dollar minted in the Spanish empire.

Until the 1857 Coinage Act, which made USD the legal currency of the United States, the currencies of Spain, Mexico and the US were all used in America at the same time.

It took an additional four years before a United States dollar was issued, and until 1869 before officials developed a standardised system for printing notes.

These notes were coined “greenbacks” due to their green colour and adopted the form that we know today in 1914 when the US Federal Reserve (Fed) was created.

Thirty years later, the USD became the global reserve currency in the Bretton Woods Agreement, with its weight initially valued in gold or silver before being traded as a paper note.

What are the current USD denominations?

Currently, the Fed prints USD 1, USD 2, USD 5, USD 10, USD 20, USD 50 and USD 100 bills; however, the USD 2 and USD 5 notes are rarer than other denominations.

The US used to print higher currency denominations, but former President Richard Nixon introduced legislation to end this when electronic banking gained popularity.

Several decades ago, it would’ve been possible to get a USD 500, USD 1000, USD 5000, USD 10,000 and USD 100,000 note, albeit the latter was only conducted for official transactions between Federal Reserve banks during the Great Depression.

The Fed also issues the following coins:

  • 1 cent (a penny)
  • 5 cents (a nickel)
  • 10 cents (a dime)
  • 25 cents (a quarter), and
  • 50 cents

US dollar world reserve currency

Is the US dollar’s status as a global currency in demise?

In recent years, the greenback’s status as the world’s reserve currency has weakened, and the coronavirus pandemic has only exacerbated signs of its demise.

Comments from the Fed and accelerating global growth weigh on the trade-weighted US Dollar Index (DXY) and benefit equities and other riskier assets.

The DXY is down by 4% from its 2021 peak, making USD the worst-performing major currency year-to-date (YTD) compared to the British pound (GBP), which has rallied by more than 3% against the greenback and the Chinese yuan (CNY), which is up by 2%.

The US dollar (USD) extended its decline against a host of major currencies in Tuesday trade as traders digested the latest comments on inflation from the Federal Open Market Committee (FOMC).

Despite data showing inflation surged in April 2021, riskier assets went higher in forex (FX) markets as Fed officials continued to pour cold water on fears over consumer prices spiralling.

Fresh declines in US Treasury yields, which fell as low as 1.56% on Tuesday afternoon, also dragged the greenback lower in currency markets.

The move showed sharp contrast to interest rates in other countries, which have been steadily climbing over the past month.

Marc Chandler, the chief market strategist at Bannockburn Global Forex in New York, said that rising interest rates in other countries make the relative local country more competitive. It seems that the current outlook for that difference is set to continue due to the Fed’s policy.

Since late March, the greenback has been in decline, pressured by expectations that lower interest rates in the US will free up cash abroad as the global economy emerges from the coronavirus pandemic.

However, the US dollar (USD) appears to be gaining ground heading into the North American session on Wednesday, following comments from Fed Vice Chairman Richard Clarida about discussing tapering measures.

US dollar rebounds after Richard Clarida spooks bears

At the time of writing, the British pound to US dollar (GBP/USD) exchange rate is trading flat at USD 1.412, while the euro to US dollar (EUR/USD) exchange rate has slumped by 0.3% to USD 1.2207.

After weeks of upside against its US counterpart, the Canadian dollar (CAD) is also floundering and was last seen trading 0.4% lower at USD 0.8249.

Vice-Chair Clarida said he acknowledges the “very unpleasant surprise”  resulting from April’s inflation and agreed that Fed policymakers need to discuss tapering in the upcoming policy meetings.

However, most of the greenback’s gains have been due to some profit-taking and a slump in crude oil prices, which has caused investors to pile into safe-haven assets.

Several of China’s commercial banks attempted to curb a rally in the Chinese yuan (CNY) on Wednesday after the currency climbed to its highest level against the greenback in two years.

Although the Chinese yuan (CNY) has climbed down from highs, the US dollar to Chinese yuan (USD/CNY) exchange rate remains under pressure heading into New York trading hours.

The shift in oil markets has also wiped-out gains in global equity markets, as European bourses and Asian indices were initially heading higher on Wednesday.

That said, European stocks look set to hold near record levels, a Reuters poll has found, boosted by hopes for a solid economic recovery following the COVID-induced downturn.

The MSCI Pan-European Index, which captures the performance of mid-cap companies across 15 Developed Markets (DM) countries in Europe, has risen by 11.5% in 2021, and the outlook for the index remains positive.

Although the Eurozone suffered a double-dip contraction in Q1 2021, large EU firms are set for double-digit profit growth this year, supported by massive stimulus packages from the European Commission.

Earlier this week, it emerged that business growth across the Eurozone had accelerated at the fastest rate since 2018. The IHS Markit Composite PMI jumped up from 53.8 in April to 56.9 in May – well above the 50-mark, separating contraction from growth.

Reuters conducted a separate poll over the past two weeks and found that strategists and brokers expect Europe’s STOXX 600 to reach 451 points by 2021-end, six points higher than Wednesday’s close.

Several strategists said they expect the US dollar (USD) to remain weak until economic indicators out of the US are strong enough to satisfy financial market participants.

CIBC Head of G10 FX Strategy Jeremy Stretch explains that the Fed’s attempts to cool inflation fears and control US yields will ensure the weak USD narrative remains intact.

US dollar (USD) price action could also trigger a rise in GBP/USD, which appears to have stalled at the USD 1.41 level after a brief climb above USD 1.42 earlier this week.

GBP/USD forecast: Pound Sterling supported by UK reopening plans

The British pound (GBP) is attempting to regain the same momentum seen during the early part of this year, where GBP/USD rallied to USD 1.423.

Although the UK is set for a robust economic recovery this year, the latest snapshot from the Confederation of British Industry (CBI) on retail sales for May disappointed foreign exchange market participants and poured cold water on GBP advances.

According to the CBI, the headline measure of retail sales fell from 20 in April to 18 in May – far lower than expectations for a rise to 24.

Separate figures from the UK government also revealed that public sector borrowing surged to GBP 20.9BN in April, the second highest for the month since the record began.

Although coronavirus lockdown easing could drive pound Sterling (GBP) higher across the board in the coming weeks, the UK currency faces the threat of the rapidly spreading Indian variant.

While experts say that the vaccines used in Britain offer protection against the Indian COVID variant, in the absence of any solid economic indicators, GBP will struggle to advance.

However, disappointing data out of the US could push GBP/USD higher. USD traders will be eyeing Thursday’s release of US Housing data, with Pending Home Sales expected to range from 0.8% to 2%.

On Wednesday, investors received data showing that US house prices rose by 2.2% in April; however, New Home Sales declined by 5.9% month-on-month, triggering some market jitters.

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