San Francisco Frontiers - The dollar's strange turn

The dollar is strengthening in currency markets while its share of global foreign exchange reserves is declining. Central banks are accumulating gold, yet digital finance is creating additional channels for holding and transferring dollars. These developments reveal a monetary system changing in several directions at once, with consequences that extend well beyond the daily exchange rate.

By 13 November, the dollar was trading near its highest level against a basket of major currencies in 19 months. The euro stood at roughly $1.10, while the Japanese yen hovered close to 160 per dollar. Two-year US Treasury yields had risen by about 34 basis points over the week to around 4.87%, reflecting a substantial reassessment of the outlook for American interest rates. Those figures sit uneasily alongside another development. In the second quarter of 2026, the dollar’s share of global foreign exchange reserves fell to 56.70%. Its position in official reserve portfolios was becoming less concentrated even as its exchange rate subsequently strengthened.

The apparent contradiction becomes easier to understand once the dollar’s different functions are separated. Its price against other currencies, its place in central bank portfolios and its use in international payments respond to different incentives and operate over different timescales.

A rally driven by uncomfortable economics
The latest advance has been supported by persistent inflation and expectations of tighter monetary policy. Stronger-than-expected inflation figures and firm comments from Federal Reserve officials pushed investors to reconsider how far US interest rates might rise.

Higher expected interest rates can support a currency by increasing the prospective return on assets denominated in it. That mechanism helps explain why troubling inflation news can coincide with a stronger dollar. Investors may respond to the anticipated policy response before the underlying economic problem has been resolved. The implications for households are quite different. A dollar that buys more euros or yen can still buy fewer goods and services at home. External currency strength and domestic purchasing power measure separate things.

For businesses, the effects are similarly uneven. A stronger dollar can reduce some import costs over time, while making American exports more expensive for foreign customers. Companies earning substantial revenues overseas can also face a reduction in the dollar value of those earnings. The exchange rate redistributes pressure across the economy; its rise alone says little about whether that pressure is becoming easier to bear.

The refuge is being judged more carefully
The dollar’s behaviour during the tariff turmoil of April 2025 exposed a vulnerability that remains relevant. American equities fell, Treasury prices came under pressure and the currency weakened. In a conventional flight to safety, investors would normally expect stronger demand for dollars and US government debt.

The unusual combination mattered because the disturbance originated partly in American policy. Investors had to assess the reliability of the assets they would ordinarily use for protection. A rise in Treasury yields can therefore carry different messages. It may reflect stronger growth or expectations of higher policy rates. It can also reflect greater compensation demanded for inflation, uncertainty or the risks associated with holding longer-term debt. The direction of yields alone cannot distinguish between these explanations.

The lesson from that episode is that the dollar’s defensive qualities depend partly on the nature of the shock. Deep markets and abundant liquidity remain considerable advantages, but their value is reinforced by confidence in policy and institutions. That confidence has to survive periods when Washington itself becomes a source of uncertainty.

A smaller share of a larger reserve pool
The reserve figures require equally careful interpretation. Global foreign exchange reserves increased from $13.10 trillion in the first quarter of 2026 to $13.22 trillion in the second. Dollar-denominated holdings were broadly unchanged, while holdings in euros and several other currencies increased. The dollar’s share consequently declined from 57.18% to 56.70% without a corresponding large-scale reduction in the amount of dollars held. The euro’s share rose from 20.04% to 20.60%, while the Chinese renminbi reached 2.11%.

This distinction changes the meaning of the numbers. Reserve managers can diversify by directing additional funds towards other currencies while retaining their existing dollar portfolios. A declining percentage does not establish that central banks are collectively liquidating American assets.
The latest quarterly changes also cannot be explained primarily by exchange-rate movements, whose valuation effects were limited during the period. Portfolio decisions and other asset-price changes played a greater role.

The resulting picture is one of gradual redistribution. The dollar remains far ahead of its nearest competitors, even as reserve managers reduce the concentration of their holdings.

Gold offers a different form of protection
Gold provides another indication of changing reserve preferences. Estimated net purchases by central banks and other official institutions reached approximately 321 tonnes in the third quarter of 2026, bringing purchases during the first nine months to about 675 tonnes. These totals include estimates of activity that has not been publicly disclosed. Reported net purchases for the third quarter were around 120 tonnes, substantially below the estimated overall figure. That gap limits how confidently individual countries’ intentions can be inferred from the headline total.

Gold has an attraction that a government bond cannot replicate: the metal itself is no other institution’s liability. It can therefore serve a distinct purpose in portfolios designed to withstand political or financial disruption. It also pays no interest and can fluctuate sharply in price. Its accumulation indicates demand for diversification and resilience, but does not establish that it can assume the dollar’s functions in lending, invoicing and everyday settlement.

The dollar remains embedded in the machinery
The structure of international finance continues to favour the US currency. In April 2025, the dollar appeared on one side of 89.2% of foreign exchange transactions, compared with 88.4% in 2022. Average daily turnover across the global foreign exchange market reached approximately $9.6 trillion.

These figures measure trading activity, a different function from the accumulation of official reserves. Each currency transaction involves two currencies, so the dollar’s participation rate should not be interpreted as a share of worldwide savings or wealth. Its extensive use nevertheless demonstrates how deeply it is embedded in financial operations. Businesses borrow in dollars, investors hedge dollar exposures and financial institutions obtain dollar funding. Existing contracts and established markets create continuing demand even when some participants would prefer greater diversification.

Replacing that infrastructure requires liquid investment markets, dependable legal arrangements and the ability to move substantial sums without excessive cost. A competing payment platform or a bilateral agreement to use another currency can change particular transactions. Reproducing the full range of dollar financing remains a much larger undertaking.

Digital finance is carrying dollars into new places
One of the most consequential changes is taking place through stablecoins: privately issued digital tokens designed to maintain a specified value, commonly one US dollar. These instruments can make dollar-denominated value accessible through digital wallets and trading platforms, including in places where conventional access to foreign-currency banking is limited. Their use creates another route through which households and businesses can save, transfer or transact in dollars.

The connection with American government debt is already substantial. Tether reported approximately $184 billion in USDT issuance and $132.4 billion in direct and indirect exposure to US Treasury bills at the end of September 2026. Its total reserve assets were approximately $191.5 billion. Those figures illustrate a financial link that can be overlooked in discussions of cryptocurrency. Demand for a privately issued digital dollar can support demand for the short-term securities used to back it. This creates an important possibility: governments may seek greater monetary independence while private users continue choosing dollar-denominated products. Official diversification and wider digital dollar access can develop simultaneously.

The arrangement also introduces additional dependencies. Users rely on an issuer’s reserves, redemption arrangements and operational systems. Digital access changes how dollar exposure is obtained; it does not eliminate the need to examine the institutions supporting it.

America’s borrowing needs remain a central weakness
The expansion of dollar access takes place against a demanding fiscal background. The United States recorded a federal budget deficit of approximately $2.0 trillion in the fiscal year ending September 2026, equivalent to 6.2% of gross domestic product. Federal debt held by the public reached approximately 100% of GDP. Persistent borrowing requires sustained demand for government securities. The Treasury market’s size is an advantage for international investors because it offers an extensive supply of tradable assets. Maintaining confidence becomes more consequential as the volume of debt increases.

Higher interest rates complicate that relationship. They can support the dollar in currency markets while increasing financing costs as the government issues new debt and refinances maturing obligations. The immediate benefit to the exchange rate can therefore coexist with a worsening fiscal burden. Stablecoin reserves add a meaningful source of demand for short-term debt, but their importance should be kept in proportion. They cannot by themselves resolve the gap between federal revenue and expenditure or remove uncertainty about future borrowing costs.

The consequences reach beyond America
For countries and companies with dollar liabilities but revenues in weaker local currencies, dollar appreciation can make debt service more expensive. Dollar-priced imports can also become harder to afford, complicating the work of central banks already facing domestic economic pressures.

These costs help explain the incentive to diversify. Yet the practical need to settle contracts, obtain financing and manage existing obligations can sustain dollar demand even among borrowers seeking to reduce their dependence. The evidence points towards a more differentiated monetary order. Reserve managers are spreading risk, digital platforms are broadening access to dollar instruments, and investors are examining American policy more closely.

What looks strange is the coexistence of these forces. A stronger exchange rate can accompany a smaller reserve share. Greater concern about US borrowing can coexist with continued demand for Treasury securities. Technologies intended to change finance can carry the dollar further into it. The decisive issue is how these relationships develop over time. America retains the benefits of a currency that much of the world continues to use. Preserving those benefits will depend on the credibility of the fiscal, monetary and institutional foundations beneath it.