Should investors be reducing exposure to the US dollar?

The greenback has for many years been the world’s primary reserve currency, and the most popular currency of choice for transactions in products and services and in capital flows. The US dollar also makes up over half of global foreign exchange reserves.

But this share of reserves has fallen from over the years, while recent weakness in the US dollar and global economic and policy developments are leading many to argue that the world should be reducing its reliance on the US dollar in international finance and reserves, in a process sometimes called de-dollarisation.

Is there therefore a case for reducing exposure to the US dollar and what are some of the practical strategies for currency diversification, especially for investment portfolios?

To answer this question, we need to first look at how the US dollar has behaved in the past and its more recent behaviour. Typically, the dollar moves in long multi-year cycles of strength and weakness. Most notably, the dollar has been in a prolonged bull market since around 2007, one of the longest on record. There are signs however that this cycle could be turning, based on several economic factors:

• A deteriorating US growth outlook: There have recently been downward revisions to US GDP forecasts and emerging signs of a slowdown (e.g. rising jobless claims and weaker housing starts).
• Fiscal and debt concerns: The US fiscal outlook has worsened and high government deficits and rising interest costs (US interest payments as a percentage of GDP are elevated relative to other major economies) are undermining confidence in the dollar. Of greatest concern is perhaps the recently passed One Big Beautiful Bill Act, which is set to increase the US debt-to-GDP ratio to about 107% by 2027, adding to pressure on the dollar and Treasuries.
• Policy unpredictability: Uncertainty in US policy and geopolitical moves can erode trust. Policies such as inconsistent tax, tariff or regulatory changes make the US a relatively less attractive place to invest at the margin, leading investors to explore other currencies.
• A changing world order: We are seeing a shift to a multipolar world, in which countries like China look to challenge US hegemony in many spheres, including payment systems and the use of the dollar as the world’s reserve currency.

As a result, investors, central banks and sovereign funds are looking at trimming US dollar holdings in favour of alternatives (more on this below).

An overvalued dollar

As with any asset, valuation is key when assessing a currency and the US dollar is no exception. When measured against its long-term purchasing power parity (PPP) level, the dollar is about 17% above fair value according to research house BCA – a level of overvaluation that has rarely been sustained. Indeed, every time in the past 50 years that the dollar has been this far above its PPP trend, it has eventually moved back into line (called mean reversion). Historically, when the dollar has been about 20% overvalued, it has tended to underperform by about 4% per year on average over the subsequent decade.

This historical valuation precedent thus supports the argument that the dollar’s recent peak will be followed by a secular weakening. However, while it may seem prudent to not be over-exposed to the US dollar from now on, it’s important to note that timing such moves can be tricky and a more responsible approach may be to diversify gradually, especially when the dollar is an investor’s base currency.

What are the benefits of de-dollarisation?

For countries and investors, holding a diversified basket of currencies, or assets like gold, is a way to mitigate the risks of a declining dollar. An added benefit is that when the dollar weakens, assets outside the US (other currencies, commodities, non-US equities) often do well, so diversification can help to capture those gains. For example, a softer dollar typically boosts commodity producing emerging markets like South Africa.

De-dollarisation is already visible in the way central banks and investors allocate assets. Central banks worldwide have gradually rebalanced their reserve portfolios away from US dollars in recent years. About 25 years ago, the US dollar made up about 70% of central bank reserves; today it’s roughly 50% on average. The euro has risen to about 20%, and many central banks have boosted their gold holdings to roughly 15% of reserves. Other currencies like the Japanese yen and British pound each make up around 5%.

Portfolio strategies and trade-offs

From a practical standpoint, there are different ways investors can diversify currency exposure in portfolios, especially for those who currently hold mostly cash in US dollars. The optimal mix depends on an investor’s objectives, risk tolerance and time horizon. For instance, someone needing maximum short-term income might stay mostly in US dollars; whereas a longer-term investor concerned about dollar decline might accept a bit less US dollar yield for more euro, yen or gold exposure. The takeaway is that even modest diversification potentially entails a small yield surrender (at current comparative bond yields in the US, Eurozone, UK, Japan and elsewhere) while improving the currency balance of the portfolio.

Investors who allocate capital that is managed against major global benchmarks will inherently achieve a level of currency and regional diversification by investing globally, notwithstanding that the reporting or investment currency may be denominated in US dollars.

This diversified currency mix is seen in global investment indices. The iShares Core MSCI World exchange traded fund (a popular global equity market benchmark) has about 70% of its value in US dollar assets, with sizeable portions in euros (about 10%), yen (about 5%), sterling (about 4%) and other currencies. Global bond indices are even more distributed: the iShares Global Government Bond Index exchange traded fund has about 54% US dollar exposure, with 24% in euro, 13% in Japanese yen and 7% in sterling. Investors tracking these indices inherently hold a mix of currencies.

Implications of de-dollarisation

Should de-dollarisation continue, we may see a more multipolar currency system in the long run. This could mean slightly higher funding costs for the US (as demand for dollars and Treasuries eases) and more volatility spread across currencies, but perhaps also a more balanced international monetary order. Already, trade blocs are experimenting with using local currencies for settlement, and the BRICS nations (a group of countries that includes Brazil, Russia, India, China and South Africa) last year raised the idea of creating a new reserve currency based on a basket of their currencies. China has also been working to increase the use of the renminbi in international flows.  

Any transition would be gradual though. The dollar’s share, while reduced, is still by far the largest global currency – as noted above, the euro is at 20%, and the Chinese renminbi is still only about 2% of global reserves. The dollar will probably remain a key pillar of the financial system, but relying on it exclusively is a growing risk.

So, in practice, de-dollarisation is an incremental process rather than a wholesale replacement of the dollar. Diversifying away from the dollar now ensures portfolios are resilient in the face of the dollar’s potential declines, while still participating in the opportunities that a changing economic landscape present.

A final word on the dollar’s status

Notwithstanding arguments in favour of de-dollarisation, calls for the demise of the US dollar as a reserve currency may be premature. In this regard we should highlight the following:

The long-term strength of the US economy: The dollar’s reserve status is underpinned by the US’s large, dynamic economy and deep financial markets. Any decision to move away from the dollar must consider whether other economies offer better long-run returns and stability. One should be careful about betting against the US, as its innovative economy and strong institutions have historically delivered solid returns for investors, supporting the currency. The recent outperformance of US firms invested in the growth of artificial intelligence are examples of the US’s leadership in major technology trends.

Purchasing power parity (PPP) limitations: In the short to medium term, exchange rates are driven by investment flows and relative growth prospects, which may put exchange rates out of sync with their longer-term PPP valuations. The dollar may stay stronger for longer if the US remains a relatively attractive place to invest in, especially if other regions have their own issues. In other words, just because the dollar is above its fair value on a PPP basis, doesn’t guarantee an immediate drop.

Safe-haven status: In times of global stress, the dollar often benefits from safe-haven flows. This suggests the dollar’s dominance could persist unless an alternative emerges that is trusted and convenient for international transactions.

These points have merit and it should be noted that the US dollar is unlikely to lose its reserve-currency crown overnight. Even on a bearish view of the US dollar, it’s unlikely to crash, but rather it will gradually weaken and cede ground at the margins.

Table 1: iShares Core MSCI World UCITS ETF percentage breakdown by currency (top 10)
 

Source: Bloomberg, 31/08/2025

Table 2: iShares Global Government Bond UCITS ETF percentage breakdown by currency (top five)
 

Source: Bloomberg, 31/08/2025

* This article was written with the assistance of artificial intelligence, based on research by the author. The article was checked and edited by the author and our editorial team.