De-Dollarization: Where Does US Dollar Demand Come From?
Explore why the US dollar remains the world’s dominant currency.
Not long ago, I wrote an article discussing popular claims about the potential fall of the US dollar as the global reserve currency. Today, I want to shift focus and explain why the US dollar is poised to retain its position as the world’s dominant currency. First, I’ll explore the key drivers of US dollar demand—its origins, global significance, and the factors behind its lasting strength.
To truly understand the value of a currency, we must first recognize the critical role of demand. Supply alone isn’t everything—no matter how limited something is, it holds no value without demand. Without it, even the rarest items would be worthless. In any market, value is ultimately shaped by the interplay of supply and demand.
This isn’t to diminish the importance of supply—it plays a significant role. However, I want to highlight the immense importance of demand in determining a currency’s relevance. When it comes to the US dollar, its demand is extraordinary—not just within the United States but across the globe. And there are compelling reasons for this widespread appeal.
When exploring the potential decline of the US dollar as the global reserve currency, it’s crucial to understand why it holds this role in the first place. The primary reason lies in the strong global demand for the US dollar. Individuals, businesses, and institutions worldwide choose to trade and save in this currency—and there are compelling reasons for this preference.
This widespread need and desire for the US dollar are the key drivers behind its strength and its status as the world’s leading reserve currency. Simply put, the demand for the US dollar is what sustains its dominance on the global stage.
Transactional and precautionary factors driving the US dollar’s global dominance
In economics, there are two primary types of demand for money. The first is transactional demand, which arises when we need a particular currency to make purchases or facilitate trade. The second is precautionary demand, which reflects our desire to hold onto a currency as a safeguard for the future
Transaction demand for money is often overlooked by US dollar skeptics when discussing the value of the dollar, yet it remains a crucial factor. Whenever people want to purchase something, they need money. More specifically, if they wish to buy goods or services from a particular country, they need that country’s currency.
When people trade with a particular country and want to buy something — food, commodities, technology, services, anything — they must acquire the currency of this country. And what happens when they acquire this currency? They create a demand for this currency — they either need to sell some goods they have or offer an interest high enough for other people to lend money.
When people want to purchase something using US dollars, they must either sell something or borrow US dollars from the market. This process naturally generates demand for the currency.
It’s important to recognize that transactional demand for the US dollar arises from all transactions involving its exchange—not just international ones. Domestic transactions within the United States also contribute significantly to the demand for the US dollar, which in turn influences its value.
Therefore, when discussing the transactional demand for the US dollar, it’s essential to consider both international and domestic transactions. Together, these dynamics shape the overall demand for the currency and reinforce its strength.
The second type of demand is precautionary demand. This refers to the money people hold as physical cash or savings in the bank, set aside for the future. Whether it’s for planned expenses, unexpected emergencies, or potential profitable opportunities, individuals keep savings to ensure they can meet their needs or capitalize on opportunities when they arise.
The more people choose to hold a particular currency, the greater the demand for that currency, which in turn enhances its value. This dynamic highlights the critical role precautionary demand plays in shaping the strength of a currency.
Precautionary demand for a currency stems directly from its transactional demand. Why? The reason is straightforward: there’s no point in holding a currency that has no demand or utility. If you can’t use it to buy anything, holding it becomes meaningless.
In this sense, precautionary demand is secondary to transactional demand. For a currency to be worth saving, it must first have value as a medium of exchange. Only when a currency proves its utility in transactions can it effectively serve as a reliable option for savings.
This is a crucial point when discussing why the US dollar holds its status as a global reserve currency—it’s inherently tied to trade and the strength of the U.S. economy. Economic theory suggests that to understand the US dollar’s significance, we must examine both domestic and international trade involving the United States. These factors play a pivotal role in establishing the US dollar as a cornerstone of global finance.
The US economy as an attractant
The United States serves as the engine of the global economy, boasting the world's largest GDP, valued at approximately $21 trillion (in constant 2015 US dollars). According to the World Bank, the United States holds the top spot as the world’s largest economy, with China coming in second.
Chart 1: Real Gross Domestic Product of the United States and China
Source: data.worldbank.org
The United States also has the eighth-highest GDP per capita in the world if we consider purchasing power parity. And that’s an important factor contributing to the strength of the US dollar and its role as a global reserve currency.
GDP is measured by measuring spending in the economy. The whole GDP of the United States is generating transactional demand for the US dollar thus propping up the value of the US dollar. This factor should never be omitted when we look at the demand for the US dollar (or the currency of any other country).
The strength of the US economy and the global prominence of US companies contribute significantly to the strength of the US dollar. Why? A robust economy offers abundant investment opportunities, and large, successful companies attract investors from around the world.
A strong economy encourages both domestic and international investment in the country and its companies. To invest, however, one must use the local currency—creating additional demand for it. As the largest and strongest economy in the world, the United States attracts substantial foreign investment, which drives up demand for the US dollar and, consequently, its value.
Why does all this matter?
When people want to purchase goods or services from a particular country, they need that country’s currency. However, there’s another side to this equation: the country must first produce something valuable for foreigners to buy.
Countries with weak economies often have weak currencies. If a country’s economy doesn’t produce much, there will be little demand for its currency. As a result, currencies from weaker economies tend to be more volatile and are more vulnerable to inflation, reflecting the underlying economic instability.
Holding the currency of a country with a strong economy offers significant advantages—it allows access to a wider variety of goods, higher-quality products, and opportunities to invest in a more stable and robust economy. These benefits contribute to sustaining and increasing the value of such currencies. Once again, it’s important to note that the United States remains the strongest economy in the world, further reinforcing the value of the US dollar.
The United States: diverse economic powerhouse and global export leader
The strength of the United States economy isn’t by chance—it’s built on a diverse foundation. At the end of 2022, all sectors involved in producing or constructing goods contributed 16% of the country’s GDP. But that’s just part of the picture. The scientific and technical services sector accounted for an impressive 7.53% of the US GDP1 (see endnotes), while the information industry added another 7%.
Together, these industries—spanning goods production, information, and scientific and technical services—represent 30.53% of the total US GDP. This highlights the diversity of the US economy, which isn’t limited to services but also thrives in science, technology, and manufacturing, both advanced and traditional.
The United States is a significant exporter of goods and services—yes, an exporter! In 2022, the value of US exports reached 3.01 trillion US dollars, close to China’s 3.34 trillion US dollars. What’s notable is that the role of the US as an exporter is steadily growing. At the end of 2019, US exports were valued at 2.55 trillion US dollars, reflecting a substantial increase over the past few years.
As the world’s second-largest exporter, the United States generates considerable demand for the US dollar. After all, anyone wanting to purchase goods or services from the US must first acquire its currency, further reinforcing the dollar’s global importance.
And what is the United States exporting? Yes, financial and insurance services, which are worth 22.69 billion US dollars and 167.73 billion US dollars respectively. But that’s not all, and those aren’t even the most important export services of the United States. More important are business services, which were worth 245.21 billion US dollars.
But what’s even more important in US exports are goods. At the end of 2022, the United States exported industrial supplies (which include petroleum and petroleum products) worth 830.8 billion US dollars and capital goods worth 572.74 billion US dollars. In the case of industrial supplies, most of them are energy resources (almost 45%), but not only. The US also exports a variety of chemicals, metals, and other kinds of supplies made of different materials. But what’s more interesting is the composition of US exports of capital goods. It contains various industrial equipment and products, like aircraft and aircraft engines, industrial engines, electrical and electronic devices, machinery, semiconductors, and other technologically advanced products.
The United States also sold some automotive products — worth 159.65 billion US dollars — and consumer goods — worth 245.7 billion US dollars.
It’s important to mention that according to the International Monetary Fund, the United States is also the country with the biggest inward foreign direct investment. That’s right — the USA is the number one country in the world to invest in. The Netherlands is second and China is third. At the end of 2021, foreign direct investment in the USA was worth almost 5 trillion US dollars.
It’s true that the United States runs trade deficits—there’s no denying that. However, this doesn’t mean the US doesn’t produce or sell anything. In fact, it exports a significant volume of goods and services, though financial services are not its primary export.
Additionally, investors and companies worldwide channel substantial investments into the US. It’s also worth noting that the US isn’t just importing consumer goods; a large portion of its imports consists of capital goods and equipment. This underscores the country’s pivotal role in the global economy. US trade deficits aren’t merely funding consumption—they’re also financing investments that drive economic growth.
The US dollar’s role in global financial systems
In Part One of this De-Dollarization series, I mentioned that the US dollar is popular outside the US. Companies around the world acquire US dollars not only when they want to buy something from the United States, but they also obtain US dollars for transactions outside the United States. Also, US dollars are popular as a form of savings among foreigners.
This highly recommended article authored by Bertaut, Beschwitz, and Curcuru, explores the significance of the US dollar in the global financial system. As highlighted below, the US dollar is the most widely used currency in international trade worldwide, with the exception of Europe, where the euro dominates.
Chart 2: Share of the US dollar in export invoicing
Source: federalreserve.gov
Another key point is that the US dollar is the most widely used currency for foreign currency debt issuance—debt issued in a currency different from the firm’s home country. About 70% of all foreign currency debt is currently denominated in US dollars. Even more striking is that this share has grown significantly, rising from approximately 55% in 2005.
Chart 3: US dollar share in the foreign currency debt issuance
Source: federalreserve.gov
Firms around the world also borrow a lot of US dollars from banks. 60% of claims in foreign currency of non-US banks are denominated in US dollars. Charts 3 and 4 present the extent of demand for the US dollar worldwide.
Chart 4: Share of foreign currency claims of banks
Source: federalreserve.org
Global claims on US dollars by banks reflect the strong demand for US dollar assets, which, as Adrian and Xie highlighted in their article2 (see endnotes), helps sustain the value of the currency.
Additionally, people outside the United States favor holding their savings in US dollars. Over 40% of all US dollar banknotes are held by non-US residents—a share that steadily increased from 2010 to 2020, as shown in the chart below (see Chart 5). While this share has remained stable since 2020, the total amount of US dollar banknotes continues to grow, indicating that foreign holdings of US dollars are still on the rise.
Chart 5: Foreigners’ share in US dollar banknotes holdings
Source: federalreserve.gov
People widely regard the US dollar as a safe asset, often turning to it to protect their savings, especially during periods of financial or economic turmoil. However, this behavior isn’t limited to times of crisis. Even in stable periods, individuals and institutions hoard US dollars to diversify their portfolios and save in a currency they trust.
The United States is strong because of its economy
The charts compiled by Bertaut, Beschwitz, and Curcuru, along with a closer look at the US economy, clearly demonstrate the substantial global demand for the US dollar. This demand isn’t driven solely by the United States' political or military influence—it stems from the strength and stability of its economy.
Those who believe the US dollar’s importance is rooted purely in political or military power are overlooking a critical point. The value and demand for any currency are fundamentally tied to the strength of the country’s economy. The global demand for the US dollar exists because businesses and individuals around the world actively choose to use it, not because of military might, but because of its economic reliability and utility.
Notes:
1) At the end of 2022, the professional and business services industry contributed 9.16% to the US GDP. Notably, 82.13% of all employees in this industry worked in scientific or technical services. Assuming each individual in the sector contributed equally to GDP, the share attributable to scientific and technical services can be estimated based on this proportion.
2) Adrian Tobias, Xie Peichu (2020). The Non-U.S. Band Demand for U.S Dollar Assets. International Monetary Fund. Working Paper WP/20/101.
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