The US dollar’s role as the world’s pre-eminent international reserve currency was first challenged by President Richard Nixon’s August 1971 decision to abandon the Bretton Woods gold standard. The introduction of the euro in 1999 created a credible alternative to the greenback. The rise of China and its ambitions to elevate the renminbi into a global trading currency are viewed by many as a further challenge. Fintech innovation has given rise to a plethora of stable coins designed to smooth international trade. Now, the adoption of wide-ranging sanctions by much of the West against Russia over its war with Ukraine — concerns about the weaponization of a reserve currency — has opened another chapter in the long-running debate about the dollar’s potential demise.

How likely is a sudden change in the status of the dollar?

The dollar’s status as the world’s leading reserve currency has eroded for some time, from around 70 percent of global foreign exchange reserves two decades ago to roughly 60 percent today. The euro’s share of foreign exchange reserves is 20 percent, with the renminbi coming in at less than three percent. In practice, the dollar’s decline has not greatly benefitted a single currency, but instead reflects the rise of several smaller currencies, such as the Korean won and the Australian dollar, as these countries have become more important exporters.

The status of the Middle East as a critical swing producer of oil along with its commitment to economic diversification makes the Gulf Cooperation Council an increasingly important player in the global economy. 

Jarmo Kotilaine

It has proved difficult to push the US dollar, which is underpinned by the world’s most liquid financial markets, off its pedestal. China’s efforts to internationalize the renminbi have been held back by its lack of full convertibility, the absence of open capital markets, and the limitations of offshore trading. As for crypto assets, all of the different digital coins are estimated at some $2 trillion, which only amounts to 16 percent of all global foreign exchange reserves.

Even in the absence of clear alternatives, the search for a new reserve currency seems irreversible. At a minimum, we are probably steadily moving toward a multi-polar reserve currency landscape — a dollar-led basket of globally traded currencies.

What are the implications of all this for Gulf countries and their long-standing dollar pegs, with the partial exception of Kuwait which uses a dollar-dominated basket?

In the short run, probably not very much. The pegs serve as a credible anchor for economies whose exports continue to be dollar-denominated oil. As observed by the International Monetary Fund, changes to the exchange rate regime may not deliver much given the current structure of these regional economies.

However, longer-term structural changes are underway. The status of the Middle East as a critical swing producer of oil along with its commitment to economic diversification makes the Gulf Cooperation Council an increasingly important player in the global economy. 

The Gulf countries for many years have diversified their foreign trade and investment profiles. The one-time dominance of oil exports to leading Organization for Economic Co-operation and Development countries has given way to a broader network of external relations, partly due to the rise of Asia and Africa. These trends are likely to continue whatever the short-term changes caused by the conflict in Europe. These realities will mean that the dominance of dollar-denominated oil in the foreign trade of Gulf countries will decline over time. More diverse trade relations will potentially create the basis for more foreign exchange policy options.

Another major structural trend has been the continued development of GCC financial markets. These regional bourses are now open to global capital and many are included in international benchmark indexes. All Gulf governments issue bonds and sukuk internationally, as do a growing number of corporates. Some of this issuance has involved currencies other than the dollar.

Significant progress has been made in introducing more sophisticated financial products such as derivative. The sophistication, versatility, and depth of the Gulf financial markets are helping create the conditions for potential modifications to the exchange rate regime as the instruments for dealing with different exchange rate dynamics come into being.

  • Jarmo Kotilaine is an economist and strategist focusing on the Gulf region. He writes on issues ranging from economic development to changes within the corporate sector.