BTC replacing the US Dollar? The Fed's seven charts tell you that replacing the US Dollar is an impossible task!

"As Bitcoin usage continues to increase, there may come a day when Bitcoin could replace fiat currencies, or even dethrone the US dollar as the international reserve currency." This statement is becoming more common as Bitcoin gradually enters the public eye, but is it really possible? This article will explore this issue from two perspectives: the application of the US dollar by the Fed and the "currency natural hierarchy." However, the conclusion may not necessarily please supporters.

The Federal Reserve (Fed) recently released a report titled "The International Role of the U.S. Dollar." The report aims to explore the application and scale of the US dollar's use. Based on various data, it believes that due to the strength of the US economy, the liquidity and depth of its financial markets, the US dollar remains the most influential currency.

The Fed uses the functions of money: value storage, exchange as the basis of argument, and examines from various measurement standards to conclude that "the US dollar remains the primary international currency."

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World's Largest Foreign Exchange Reserves

According to IMF COFER data (Figure 1), the US dollar accounts for 60% of the officially disclosed foreign exchange reserves of countries worldwide. While this figure has decreased from 71% in 2000 to 60%, it still far surpasses other fiat currencies, including the Euro at 21%, the Japanese Yen at 6%, the British Pound at 5%, and the Chinese Renminbi (RMB) at only 2%.

Most of these official US dollar reserves are held in the form of US Treasury bonds. Demand for US Treasury bonds is significant not only among official entities but also among private investors. As of Q1 2021, a total of $7 trillion (33% of total circulation) is held by foreign official or private investors, with 42% held by US domestic private investors, and interestingly, around 25% held within the Federal Reserve System (Figure 2).

It is worth mentioning that since 2015, the proportion of foreign investors holding US Treasury bonds has been decreasing, currently roughly equivalent to the proportion of Eurozone government debt but still higher than that of UK and Japanese government bonds.

However, the decline in the proportion of holdings is due to the fact that both Europe and Japan have also issued a large amount of base currency, causing a decrease in their respective proportions.

In addition to government bonds, foreign investors also hold a "significant amount of US banknotes." Over the past 20 years, the value and quantity of US banknotes held by foreigners have increased. As of Q1 2021, foreign-held US banknotes exceeded $950 billion, accounting for half of the outstanding US banknotes.

However, the $950 billion is only an estimate, as it is difficult to accurately assess the amount of US dollars held by foreigners. The $950 billion may be a conservative estimate.

Furthermore, the US dollar is also considered a "Anchor Currency" for many countries. This means that many countries purchase "US dollar-denominated assets" to adjust the exchange rates of their national currencies. Data shows that in 2015, 50% of the world's total GDP was produced by countries where the currency is anchored to the US dollar (excluding the US), while countries anchoring to the Euro accounted for only 5% of GDP.

The Role of the US Dollar in International Financial Trade

The US dollar also serves as a "medium of exchange" in international finance, and almost all studies related to global trade and international finance emphasize the importance of the US dollar.

Studies indicate that from 1999 to 2019, the US dollar accounted for 96% of invoices issued for trade in the Americas, 74% in the Asia-Pacific region, and excluding the Euro and the aforementioned two regions, the US dollar accounted for 79% of invoices (Eurozone transactions are primarily in Euros).

Moreover, the US dollar is the "dominant currency" among international banks and also the "pricing currency" for foreign debt.

According to BIS data, approximately 60% of international debt, foreign liabilities (mainly deposits), and claims (loans) are denominated in US dollars, a figure that has remained stable over the past 20 years. In comparison, debt and liabilities denominated in Euros account for only 20%.

Bonds issued in "foreign currencies other than the domestic currency" are also dominated by the US dollar, at around 60%, a figure consistent with the proportion of international debt denominated in US dollars.

The US dollar's position can also be seen in the Foreign Exchange Market.

The foreign exchange market is the most liquid financial market globally, with participants including central banks, large commercial banks, institutional investors, and governments. The daily trading volume of the foreign exchange market is $6.6 trillion.

IMF conducts a survey every three years, and in April 2019, approximately 88% of global foreign exchange transactions involved buying or selling the US dollar, a figure that has remained stable over the past 20 years. In comparison, the Euro accounted for 32% of transactions in 2019, down from 36% in 2010.

[Note]: The total sum of foreign exchange transactions is 200% because each transaction involves 2 currencies.

Fed's Conclusion: Stability of the US Dollar's Position

From the application data of the US dollar, it seems that the US dollar's position has remained stable over the past 20 years, contrary to common beliefs.

How stable is the usage rate of the US dollar exactly?

Fed constructs a comprehensive index of international currency usage using five metrics (in a time series): official currency reserves, foreign exchange trading volume, outstanding foreign debt, cross-border deposits, and cross-border loans. The US dollar index derived from these five metrics is approximately 75, significantly ahead of other currencies.

The second-highest currency value is the Euro, at only 25. The British Pound and Japanese Yen are around 10, while the Chinese Renminbi approaches 0.

The report concludes:

In conclusion, unless there are significant political or economic changes that impair the value of the US dollar as a store of value and medium of exchange, while at the same time, a strong and viable alternative emerges, the US dollar is likely to remain the dominant global currency in the foreseeable future.

Conclusion

Since the 2008 financial crisis, the Federal Reserve has implemented quantitative easing (QE) to rescue the economy, leading to an influx of cheap hot money into the market. It is undeniable that this has eroded the purchasing power of fiat currencies, coupled with central banks' "2% inflation target" each year, making it understandable why some in the community hope for a fixed supply of Bitcoin to gradually replace fiat currencies.

Believers seem to think that as Bitcoin price volatility decreases, discovering its true value will allow for value predictions based on demand, and even serve as a "global pricing unit." Is this possible?

Almost impossible.

From the Fed's report, it is evident that over the past two decades, while the international share of US Treasury bonds has slightly decreased, the US dollar's position as a reserve currency and pricing unit for debt remains unshakable. In addition to the US's political and economic status, the inheritance of the gold standard in international settlement is another major factor.

As an international settlement currency, the US dollar has become the top of the "Money Hierarchy."

Most people place money or all commodities on the same level, but in reality, the entire monetary system has tiers that expand or contract with economic growth and decline.

In the next chapter, the author will further explain the monetary hierarchy and why Bitcoin is unlikely to replace the US dollar, let alone fiat currencies.