The decline of the dollar hegemony. But other options are also shaky.
By Wolf Richter for WOLF STREET.
The global share of US dollar-denominated foreign exchange reserves – these are financial assets such as US government bonds, US corporate bonds, US mortgage-backed securities, etc., which are held by foreign central banks – fell to 59.2% in the second quarter, This emerges from the data published today by the IMF on the composition of the official foreign exchange reserves (COFER). In the fourth quarter of last year, the dollar share hit a 25-year low of 58.9%. And as it stands, the dollar is continuing its long, slow, uneven downtrend (2014 is the start of quarterly data, previous data is annual):
The Fed is a ruthless money printer, and the U.S. government, which has been running on deficits for years, has gone wild since March 2020. But central banks and governments of other large developed economies also participated in this program, some worse. And so the pandemic has not changed relationships, leaving intact the long-term downtrend of the dollar as the dominant reserve currency.
Since 2014, the dollar’s share has fallen by 6.8 percentage points from 66% to 59.2%, an average of almost 1 percentage point per year. At the pace of the past six years, the dollar’s share of global reserve currencies would fall below 50% in about a decade.
The Fed’s own holdings of dollar-denominated assets – mostly $ 5.4 trillion in government bonds and $ 2.5 trillion in MBS – are not included in global foreign exchange reserves. Neither does the ECB’s holdings of euro-denominated securities. It also excludes the Bank of Japan’s holdings of yen-denominated securities, etc. Only the assets of each central bank denominated in foreign currency are included.
The introduction of the euro didn’t help the dollar: two decades of decline
In 2001 the dollar’s share of foreign exchange reserves rose to 71.5%, after which the last phase of the dollar’s long-term decline began. It is also the time for the full introduction of the euro. Since then, the dollar share has fallen by 12.3 percentage points to currently 59.2%.
But there was a spectacular collapse in the dollar’s share of global reserve currencies, beginning in 1978 and bottoming out in 1991, reflecting the years of massive inflation in which the dollar lost about half of its share. It then recovered until the euro emerged (year-end% shares, except for 2021 = Q2):
Exchange rates have something to do with it.
Central banks hold foreign exchange reserves denominated in various currencies. For example, the People’s Bank of China holds around $ 3.1 trillion in foreign exchange reserves denominated in all possible currencies. Of this, US $ 1.1 trillion is US Treasury bonds denominated in USD. The remaining $ 2 trillion in reserves consists of undisclosed amounts of yen-denominated securities, euro-denominated securities, and so on. When compiling its COFER data, the IMF converts all non-dollar amounts into USD.
The share of the dollar in the total foreign exchange reserves depends to a certain extent on the exchange rates of these other currencies against the USD.
And the exchange rates have fluctuated a lot. But since 1999, roughly the time since the euro was unleashed, the dollar index (DXY) has barely changed, despite sharp upward and downward movements.
And the long-term decline in the dollar’s share of global foreign exchange reserves over this period is not due to exchange rates, but rather to central banks discharging dollar-denominated assets (data via YCharts):
Dollar vs. Euro vs. Also-rans vs. Chinese RMB.
The euro share in the world reserve currencies has remained relatively stable over the past few years at just over 20%. In the second quarter it was 20.5%. It was the second largest reserve currency during its existence. The glowing hopes of the early years of the euro for “parity” with the dollar were vigorously shattered in the wake of the euro debt crisis.
All other reserve currencies combined, including the Chinese renminbi, accounted for 20.2% in the second quarter. You are the spaghetti at the bottom of the table. The RMB, which became the official reserve currency in 2016, was supposed to blow the dollar away; it’s the short red line below:
The graphic below is a close-up of the followers on a scale from 0% to 6%. The yen stands out in the group because it has grown significantly in recent years, to currently 5.8%.
Note the increase in the RMB (red line) of around 1% when it first became a separately quoted reserve currency in the fourth quarter of 2016 and was removed from the “Other” category, the share of which then fell (yellow line).
Almost five years after its introduction as the official reserve currency, the RMB share reached 2.6%. People who hoped the RMB would pull the rug out from under the dollar need to be extremely patient.
The RMB became the fifth largest reserve currency – behind USD, EUR, YEN and GBP – in 2018 when it outperformed the Canadian dollar and Australian dollar.
The very slow development of the RMB, which is only visible under this kind of magnifying glass, shows that central banks around the world remain suspicious of the RMB – the only reserve currency in existence quiet not fully convertible, which further hinders adoption.
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