Central banks globally are adjusting their reserve holdings, and recent data reveals a notable trend: the proportion of US dollar reserves has decreased. According to the International Monetary Fund’s (IMF) Currency Composition of Official Foreign Exchange Reserves (COFER) survey, the US dollar’s share dropped to 59 percent in the fourth quarter of 2020. This marks the lowest point in 25 years and sparks discussions about the dollar’s evolving role in the international financial system. While this shift doesn’t mean the dollar is losing its dominance overnight, it signals a gradual diversification in central bank reserve portfolios, influenced by factors ranging from exchange rate dynamics to strategic economic policies. Understanding these shifts is crucial for grasping the current and future dynamics of the global economy, especially when considering currency values and exchange rates, such as the relationship between the euro and the US dollar.
Looking at the broader picture, since the euro’s introduction in 1999, the decline in the dollar’s share of global reserves is evident. It has fallen by 12 percentage points from 71 percent to 59 percent. This long-term trend, illustrated in the chart below, includes periods of fluctuation, but the overall direction points downwards for the dollar’s share. Conversely, the euro’s share has remained relatively stable, hovering around 20 percent. Interestingly, other currencies, including the Australian dollar, Canadian dollar, and Chinese renminbi, have collectively seen their share increase to 9 percent in the same period, indicating a diversification beyond the traditional dominance of the US dollar and the euro.
Exchange rate volatility plays a significant role in these shifts. When the US dollar weakens against other major currencies, the value of reserves held in those other currencies increases in dollar terms, naturally reducing the dollar’s share of the total. The reverse occurs when the dollar strengthens. Furthermore, changes in the valuation of government securities can also have an impact, although this effect is generally less pronounced due to the correlated movement of bond yields across major currencies. Several factors can influence US dollar exchange rates, including differing economic trajectories between the US and other nations, variations in monetary and fiscal policies, and central bank interventions in foreign exchange markets.
Examining the past two decades, the US dollar’s value against major currencies has shown no significant net change. However, within this period, considerable fluctuations have occurred. These fluctuations significantly explain approximately 80 percent of the short-term (quarterly) changes in the US dollar’s proportion 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 to manage their own currency values and reserve compositions.
Considering the past year, after adjusting for exchange rate movements, the US dollar’s reserve share remained relatively stable. However, the long-term perspective reveals a more profound trend. Despite the dollar’s value remaining broadly consistent over two decades, its declining share in global reserves suggests a gradual strategic shift by central banks away from the US dollar. This indicates a conscious move towards diversifying currency holdings, rather than a simple consequence of exchange rate fluctuations.
Looking ahead, it is anticipated by some analysts that the US dollar’s share in global reserves will continue to decrease. This expectation is driven by emerging market and developing economy central banks seeking greater diversification in their reserve currency portfolios. Some nations, like Russia, have already publicly announced their intentions to reduce their reliance on the US dollar.
Despite these shifts and predictions, it’s crucial to remember that the US dollar remains the world’s dominant international reserve currency. While diversification is underway and the dollar’s share is gradually decreasing, significant changes to the dollar’s status are expected to be long-term processes. The global financial system evolves slowly, and the dollar’s entrenched position means any transition will likely be gradual rather than abrupt.
