Iran-US Conflict Leaves Lasting Impact on Global Currency Stability

Global Trading System Under Strain as Gold Reserves Surpass Dollar Holdings

The recent conflict between the US and Iran has put a potentially irreversible strain on the global trading system, with gold reserves having eclipsed central bank holdings of valuation-adjusted dollar assets for the first time in several decades. The announcement of a ceasefire between the two nations has brought a temporary reprieve, but the long-term effects of the conflict are likely to be lasting.

The dollar's demise has been greatly exaggerated in the past, but it will not be a dramatic point-in-time event. The decline of sterling as a reserve currency was punctuated by several milestones over an extended period, including the end of World War I, coming off the Gold Standard, Bretton Woods, and the Suez crisis. The US currency has just passed another milestone in its declining dominance, with dollar-denominated reserves adjusted for valuation effects now lower than gold reserves for the first time since the International Monetary Fund started publishing the data in the late 1990s.

Comparison of Dollar and Gold Reserves

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Note: Adjusted value of dollar reserves excludes interest earned on them.

The adjusted value of dollar reserves has fallen 15% since official holdings of the US currency peaked around 2014, while central banks have increased their physical holdings of bullion, in tons, by 15%. This suggests that actual demand for dollars has been materially softening.

The market has re-aligned on the age-old solution of gold as unimpeachable global collateral, to the detriment of the US currency, after growing distrust in the dollar standard and a lack of viable alternatives to assets separate from the financial system. We can see it in the changing behavior of global central banks, which were previously opportunistic traders of dollars, but are now no longer buying dollars when the currency falls.

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Pressures on the Dollar System

Pressures on the dollar system are also coming from higher energy prices and ongoing supply constraints. Oil and gas prices are significantly lower after the ceasefire announcement, but are still much higher than they were before the war. This is putting increased strain on energy importers to raise dollars by liquidating assets. Energy exporters unable to sell their product have been facing their own cashflow pressures, leading to gold and Treasuries rallying when tensions eased and vice versa.

However, there's a much deeper and long-lasting issue. The quid pro quo that forms the backbone of the global monetary system – that trade proceeds are recycled into dollar assets, allowing the US to fund cheaply, in return for security guarantees and the stability of the global system – can no longer be taken as read.

The dollar carousel that has underpinned the global monetary system is coming under increasingly grave strain. As stated, this is not an overnight phenomenon, but a current lack of alternative reserve and financing assets ensures that, but that doesn't mean there isn't a puncture and the air won't continue to escape.

Gold's ascendancy is but one warning, but others are getting louder. Global trade in dollars has fallen to around 40% in the last few years, while that in euros and the yuan has picked up. Dollar-denominated international loans have slipped back to 60% of the global total, and central bank holdings of Treasuries are now less than their holdings of gold. The dollar as a share of global FX and gold central bank holdings is falling rapidly.

After the unilateral actions of the US in the Iran war, everyone now knows that everyone knows the rules of the game have changed. Owning fewer dollar assets becomes increasingly logical. Now that is common knowledge, it's hard not to see the dollar's dominance continuing to ebb away over time, and gold's fortunes further revived.