Rise of “non-traditional” reserve currencies lessens dollar dominance
The status of the US dollar as the dominant global reserve currency shows few signs of declining, despite a wave of challenges from Russia and China, as MarketWatch reported this week.
But if the dollar does eventually cede its status as the most popular currency for central bank reserves, international trade and bank deposits, then this latest data point will likely be remembered as a milestone.
On Thursday, the International Monetary Fund announced that the percentage of international currency reserves denominated in dollars fell below 59% to a new low of 58.81%.
To help put this into context, it should be noted that the IMF has been collecting data on international reserves since 1995. Since there are no reliable data on international reserves before that date, it is likely that this new trough is in fact the lowest concentration of dollar holdings in international reserves since the Bretton-Woods collapse in the early 1970s.
The last update dates back to the fourth quarter of 2021.
As the role of the dollar in foreign exchange reserves has diminished, central banks around the world have diversified into a number of different international currencies. Analysts argued that this could be interpreted as a positive for the dollar’s continued dominance, since the international community has yet to coalesce around a single challenger currency.
Instead of diversifying into Euros or Japanese Yen USDJPY,
central banks instead favored a handful of smaller rivals, including the South Korean won USDKRW,
and the Swedish krona USDSEK,
– with the Australian USDAUD,
and Canadian dollars USDCAD,
Currencies of smaller economies have accounted for three-quarters of the dollar’s recent drop, as illustrated by the IMF in the chart below:
According to the IMF blog, this is why small currencies are favored.
“These currencies combine higher returns with relatively lower volatility. This is increasingly attracting central bank reserve managers as currency stocks grow, raising the stakes for portfolio allocation.
“New financial technologies – such as automatic market making and automated liquidity management systems – are making it cheaper and easier to trade the currencies of smaller economies.”
Additionally, central bankers can be assured that these currencies will experience little volatility since they benefit from bilateral swap lines with the Federal Reserve, which builds confidence in their ability to hold their value against the dollar.
In some cases, the issuers of these currencies have also bilateral swap lines with the Federal Reserve. This, it may be said, creates trust that their currencies will retain their value against the dollar.
Another plausible explanation: these “non-traditional” reserve currencies benefit from open capital accounts and a solid track record of sound and stable monetary policy.
The importance of maintaining an open capital account highlights another interesting feature of the latest IMF data: while the Chinese yuan USDCNY,
has seen its share of global reserves increase, the increase has been relatively lackluster, with Russia alone accounting for almost a third of all foreign renminbi reserves.
Although there has been some increase in the share of reserves held in renminbi, the Chinese currency accounts for only 25% of the abandonment of the dollar in recent years.
Certainly, the share of the dollar in international reserves remains well above half, and its dominance in world trade is even greater. The dollar accounted for 96% of commercial billing in the Americas, 74% in the Asia-Pacific region and 79% in the rest of the world in the 20 years between 1999 and 2019.
In terms of market performance, the dollar DXY,
also continued to dominate on the back of an attractive interest rate differential and safe-haven flows: a popular gauge of the dollar’s value touched its highest level since 2002 earlier this year.