The global financial landscape is constantly evolving, and one significant indicator of this shift is the composition of central bank reserves. Recent data from the International Monetary Fund (IMF) reveals a noteworthy trend: the share of US dollar reserves held by central banks globally has declined to 59 percent in the fourth quarter of 2020. This marks the lowest level in 25 years, prompting discussions about the US dollar’s role in the international economy. This analysis, drawing from the IMF’s Currency Composition of Official Foreign Exchange Reserves (COFER) survey, explores this trend, examining the factors contributing to this change and its potential implications for the future of international finance.
This downward shift in US dollar holdings is interpreted by some analysts as a reflection of the dollar’s gradually diminishing dominance in the global economy. As other currencies become more prominent in international transactions, central banks are diversifying their reserves, moving away from a heavy reliance on the US dollar. These shifts in reserve allocations, if substantial, can have tangible effects on currency and bond markets, making it crucial to understand the underlying dynamics.
Looking at the Long-Term Trends
To gain a deeper understanding, examining the long-term perspective is essential. The data illustrates a clear trend since the introduction of the euro in 1999. At that time, US dollar assets constituted 71 percent of central bank reserves. Since then, this share has decreased by 12 percentage points, falling to the aforementioned 59 percent. While there have been fluctuations during this period, the overall trajectory points downwards for the dollar’s share.
Alt text: Chart showing the decline in US dollar reserves held by central banks globally since the launch of the Euro in 1999, with fluctuations indicated and comparison to the Euro and other currencies share.
In contrast to the US dollar’s declining share, the euro’s share of global reserves has remained relatively stable, hovering around 20 percent. Interestingly, the combined share of other currencies, including the Australian dollar, Canadian dollar, and Chinese renminbi, has seen an increase, reaching 9 percent in the fourth quarter of the studied period. This indicates a diversification trend beyond just the euro, suggesting a broader shift in reserve currency preferences.
The Impact of Exchange Rate Fluctuations
It’s crucial to acknowledge the significant influence of exchange rate fluctuations on the currency composition of central bank reserve portfolios. When the US dollar weakens against other major currencies, the dollar-measured value of reserves held in those other currencies naturally increases. Conversely, when the US dollar strengthens, its share of global reserves tends to rise. Changes in the relative values of government securities can also play a role, although this effect is typically less pronounced due to the correlated movements of major currency bond yields.
Over the past two decades, the value of the US dollar against major currencies, when viewed broadly, has not experienced a dramatic net change. However, significant short-term fluctuations have occurred. These fluctuations can explain a substantial portion – approximately 80 percent – of the short-term (quarterly) variations observed in the US dollar’s share of global reserves since 1999. The remaining 20 percent of short-term variance is largely attributed to the active decisions of central banks buying and selling currencies, often to manage their own exchange rates.
Considering the impact of exchange rate movements over the past year, data suggests that once these movements are factored in, the US dollar’s share in reserves has remained relatively stable. However, when we take a longer view, the fact that the US dollar’s value has remained broadly unchanged while its share of global reserves has declined indicates a deliberate and gradual shift by central banks away from the US dollar. This suggests a strategic diversification rather than just a passive effect of exchange rate changes.
Looking Ahead: Continued Diversification?
Looking to the future, some analysts anticipate a continued decrease in the US dollar’s share of global reserves. This expectation is driven by the increasing desire among emerging market and developing economy central banks to further diversify their reserve currency holdings. Countries like Russia have already publicly announced their intentions to reduce their reliance on the US dollar and diversify into other currencies.
Despite these shifts and the evolving international monetary system over the past six decades, the US dollar continues to hold its position as the dominant international reserve currency. However, as the data indicates, any changes to the US dollar’s status are likely to be a gradual, long-term process. The trend of diversification suggests a move towards a more multi-polar reserve currency system, but the US dollar’s entrenched position means it will likely remain a central pillar of global finance for the foreseeable future.
