The global financial landscape is witnessing a subtle yet significant shift in the composition of central bank reserves. Recent data from the International Monetary Fund (IMF) reveals that the U.S. dollar’s share of these reserves has dipped to 59 percent in the fourth quarter of 2020 – a level not seen in the last 25 years. This development has sparked discussions among analysts about whether this decline signifies a weakening grip of the dollar on the global economy, especially with the euro and other currencies vying for prominence in international transactions. For markets worldwide, substantial shifts in central bank reserve allocations can trigger notable ripples across currency and bond markets.
Our analysis focuses on these evolving trends, providing a long-term perspective on the latest IMF data. The data highlights a compelling narrative: since the euro’s inception in 1999, the U.S. dollar’s reserve share has contracted by a significant 12 percentage points, falling from 71 to 59 percent (as illustrated in the chart below). While this descent hasn’t been a straight line – marked by intermediate fluctuations – the overall trend is undeniable. Conversely, the euro’s share has generally hovered around the 20 percent mark. Interestingly, other currencies, including the Australian dollar, Canadian dollar, and Chinese renminbi, have collectively seen their share rise to 9 percent by the end of 2020.
Alt text: Chart showing the decline of US Dollar reserves to 59 percent since the Euro launch in 1999, with the Euro share fluctuating around 20 percent and other currencies rising, illustrating the shift in global central bank holdings and the evolving dynamic of the 60 euro dollar landscape.
Exchange Rate Dynamics and Reserve Currency Shifts
Exchange rate volatility plays a crucial role in shaping the currency composition of central bank reserve portfolios. Fluctuations in the relative values of government securities also exert influence, although this impact tends to be less pronounced due to the generally correlated movements of major currency bond yields. Typically, periods of US dollar depreciation against major currencies coincide with a decrease in the dollar’s share of global reserves. This is because the dollar value of reserves denominated in other currencies increases during dollar weakness, and conversely, decreases when the dollar strengthens. Several factors can influence US dollar exchange rates, including diverging economic trajectories between the United States and other nations, variations in monetary and fiscal policies, and central banks’ foreign exchange operations.
The lower section of the chart provides further insights by tracking the US dollar’s value against major currencies. Over the past two decades, this value, represented by the black line, has remained relatively stable overall. However, the interim period has witnessed considerable fluctuations. These exchange rate movements can account for approximately 80 percent of the short-term (quarterly) variance in the US dollar’s share of global reserves since 1999. The remaining 20 percent of short-term variance is largely attributable to active buying and selling decisions by central banks aimed at managing their own currencies.
Long-Term Trends: Beyond Exchange Rate Noise
Focusing on the past year, after adjusting for the effects of exchange rate movements (indicated by the orange line), the US dollar’s reserve share appears to have remained largely consistent. However, when we adopt a broader, long-term perspective, a significant trend emerges. Despite the dollar’s value remaining broadly unchanged over time, its share of global reserves has declined. This divergence suggests a gradual shift away from the US dollar by central banks, indicating a move towards diversification.
Looking ahead, some analysts anticipate a continued decrease in the US dollar’s share of global reserves. This expectation is driven by emerging market and developing economy central banks seeking to further diversify their reserve currency holdings. Certain nations, like Russia, have already publicly stated their intentions to reduce their dollar dependency.
The Enduring Legacy of the Dollar
Despite substantial transformations within the international monetary system over the last half-century, the US dollar continues to be the dominant international reserve currency. However, as our analysis indicates, the trend suggests a gradual erosion of this dominance. While the dollar remains central, any fundamental shifts in its status are likely to unfold over the long term, reflecting the slow-moving nature of global financial transformations. The idea of a swift transition to a “60 Euro Dollar” world, where the euro or other currencies rapidly displace the dollar, seems unlikely in the immediate future. Instead, a more gradual rebalancing, with the dollar maintaining a significant but potentially reduced share alongside a stronger euro and other currencies, appears to be the more probable trajectory of the global reserve landscape.
