The dominance of the US dollar in global finance is being increasingly scrutinized as central banks diversify their reserve holdings. Data from the International Monetary Fund (IMF) reveals a significant shift: the share of US dollar reserves held by central banks globally fell to 59 percent in the fourth quarter of 2020. This marks the lowest point in 25 years, according to the IMF’s Currency Composition of Official Foreign Exchange Reserves (COFER) survey. This trend sparks debate about the evolving role of the US dollar in the international economic landscape, especially as other currencies gain traction in international transactions. Significant shifts in central bank reserve allocations can have considerable impacts on currency and bond markets, making this a crucial area of observation for global finance.
The 25-Year Trend: Dollar vs. Euro and Rising Currencies
Looking back over the past quarter-century, particularly since the introduction of the euro in 1999, the decline in the US dollar’s reserve share becomes more apparent. As depicted in the IMF data, the dollar’s share has decreased by a notable 12 percentage points, dropping from 71 percent to 59 percent since the euro’s inception. While there have been fluctuations during this period, the overall trend (illustrated by the blue line in the chart) indicates a consistent erosion of the dollar’s dominance.
In contrast, 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 a rise, reaching 9 percent by the end of 2020 (represented by the green line). This suggests a broader diversification trend beyond just the euro, with central banks exploring a wider array of currencies for their reserves.
Exchange Rate Impact and Central Bank Actions
Exchange rate volatility plays a significant role in the currency composition of central bank reserves. When the US dollar weakens against other major currencies, the dollar-denominated value of reserves held in those other currencies naturally increases, leading to a decrease in the dollar’s overall share. Conversely, a strengthening dollar tends to increase its share of global reserves. While changes in government securities values can also have an effect, their impact is generally less pronounced as major currency bond yields tend to move in tandem.
The historical data, as shown in the bottom panel of the IMF chart, indicates that the value of the US dollar against major currencies has remained largely consistent over the last two decades (black line). However, significant short-term fluctuations have occurred. These exchange rate movements can account for approximately 80 percent of the short-term variance in the US dollar’s share of global reserves since 1999. The remaining 20 percent of this short-term variance is largely attributed to the active decisions of central banks buying and selling currencies to manage their own exchange rates and reserves.
Long-Term Shift Away from the Dollar
Analyzing the trends over a longer period reveals a crucial insight. Even when accounting for exchange rate fluctuations (orange line in the chart), the underlying trend shows a gradual decline in the US dollar’s share of global reserves. This suggests a deliberate shift by central banks away from the US dollar, beyond just the effects of currency valuation changes.
Looking ahead, many analysts anticipate this diversification trend to continue. Emerging market and developing economies, in particular, are expected to further diversify their reserve portfolios, reducing their reliance on the US dollar. Some countries, like Russia, have already publicly announced their intentions to decrease their dollar holdings.
Dollar Still Dominant, But Change is Gradual
Despite these shifts and the decline to a 25-year low, it’s important to remember that the US dollar remains the world’s dominant international reserve currency. The IMF emphasizes that while structural changes are occurring in the international monetary system, any significant changes to the US dollar’s status are likely to be a slow and gradual process, unfolding over the long term. The trend suggests a slow but persistent diversification in global central bank reserves, moving away from complete reliance on the US dollar, but the dollar’s reign is far from over.
