The Dollar's Decline as a Reserve Currency and the Emerging Multicurrency System
Newspapers are full of stories and learned commentaries about the decline in the US dollar as the premier international reserve currency. These reports, to the extent that they are based on any facts, tell only a small part of the story of the evolution of international reserve holdings in recent years. The real news is that the world is moving rapidly toward a multicurrency international reserves system. The US dollar is less dominant, and there are many other currencies in the mix—including, increasingly, non-traditional minor reserve currencies.
As the first chart below shows, the US dollar's value share of foreign exchange reserves has declined from 71 percent at the end of the first quarter of 1999 to 62 percent at the end of the fourth quarter of 2011, an average of three-quarters of a percentage point a year.1
The gradual downtrend primarily reflects changes in the currency composition of foreign exchange reserves of the developing countries, whose reported share of dollar holdings declined from 75 percent 12 years ago to about 57 percent. More importantly, developing countries account for 57 percent of the total reserves of countries that report the currency composition of their reserves, a dramatic increase from 12 years ago, when their share was only 28 percent.2 Nevertheless, the dollar's share in the foreign exchange reserves of all countries and in the reserves of developing countries has fluctuated around 60 percent and 58 percent respectively since second quarter of 2009.
Turning to the euro—the major challenger to the US dollar as the principal reserve currency, at least until the recent sovereign debt crisis in Europe—the second chart below shows that most of the increase in the euro's share of foreign exchange reserves occurred before the end of 2004. The euro's share in the reserves of the now dominant reserve accumulators, the developing countries, peaked at just over 31 percent in the second quarter of 2005 and has since declined to 27.5 percent. For all countries as a group, the euro's share has fluctuated between 25 and 28 percent since the end of 2006.
The aggregate data suggest that there is more behind countries' reserve currency preferences than a steady shift away from dollar-denominated assets toward assets denominated in euro. Indeed, since the end of the second quarter of 2009, the combined share of the US dollar and the euro in reported foreign exchange holdings of all countries has declined from 90.4 percent to 87.2 percent. That 3.2 percentage point decline, again, was driven by changes in the combined holdings of the developing countries, which went from 90.1 to 85.9 percent. This change represented a decline of 4.2 percentage points, compared with a decline of only 1.4 percentage points for the advanced economies as a group. However, the statistical beneficiaries were not the other traditional minor reserve currencies in the IMF's tabulation: pound sterling, Japanese yen, and Swiss franc. Those gaining in shares were the aggregate of "other currencies" whose combined share was boosted by 2.9 percentage points into the third position for all reporting countries and by a substantial 4.4 percentage points in the reserves of the developing countries. See the table below.
|Table 1 Value shares of international reserves (percent)|
|All countries||Advanced countries||Developing countries|
|2009 Q2||2011 Q4||Change||2009 Q2||2011 Q4||Change||2009 Q2||2011 Q4||Change|
Unfortunately, we do not know identities of these other currencies. No doubt, some countries are holding assets in Chinese yuan. Various reports indicate the increased attractiveness of the "other" dollars—those of Australia, Canada, and New Zealand.
The time has come for the International Monetary Fund (IMF) to collect more comprehensive data.
The time has long since passed when China and other countries should be allowed to continue their practice of declining to disclose the currency composition to the IMF on a confidential basis.
A Note on Interpreting the Data
Interpreting the aggregate currency composition of foreign exchange reserve holdings is complicated by many factors. Preferences differ across countries and over time. The aggregates are affected by the pace of reserve accumulation and the data on value shares are affected by movements of exchange rates relative to the dollar, or relative to whatever numeraire is used in the analysis.
The latest Currency Composition of Official Foreign Exchange Reserves (COFER) data released by the IMF on March 30 illustrate two of those points.
First, over the second half of 2011, the allocated foreign exchange reserves—those whose currency composition is reported to the IMF—increased only 2.5 percent. The holdings of developing countries actually declined by $55 billion as the currencies of a number of emerging market and developing countries came under pressure from the increased risk aversion and related developments associated with the euro area's sovereign debt crises. Since the principal intervention currency for most, but not all, countries is the US dollar, these developments suggest that some reserve holdings in US dollar assets were run down as countries defended their currencies from depreciation.
Second, however, between middle of 2011 and the end of the year, the dollar appreciated by 11.7 percent against the euro, 12.8 percent against the Swiss franc, and 3.5 percent against the pound sterling, while depreciating 3.7 percent against the Japanese yen, tending to reduce the dollar value of holdings of the first three currencies.
The third chart below shows the US dollar's quantity shares of reported foreign exchange reserves; the quantity shares are adjusted for the influence of movements of exchange rates. In contrast with the pattern shown in the first chart, there has been more of a pronounced decline of the US dollar's quantity share of the allocated foreign exchange holdings in recent years, in particular, on the part of developing countries.
Moreover, during the second half of last year, the quantity share of US dollar holdings continued to decline, perhaps influenced by intervention sales of dollars by some countries, in contrast to the stability of the dollar's value share shown in the first chart. For all countries, the dollar's quantity share was flat, rather than rising. For the advanced countries, the dollar's share rose in both charts, probably reflecting the large Japanese intervention operations to prevent its currency from appreciating in the fall of 2011.
1. The data in the chart are from the International Monetary Fund (IMF), Currency Composition of Official Foreign Exchange Reserves (COFER). Members of the IMF and Hong Kong and Taiwan report quarterly to the IMF their official foreign exchange holdings. The vast majority of countries accounting currently for 55 percent of total foreign exchange reserves also report the currency composition of their reserves to the IMF, "allocated reserves" in IMF parlance. China and Taiwan are known to be the principal countries that do not do so, accounting for almost 80 percent of the unallocated foreign exchange reserves.
2. The overall share of developing countries' foreign exchange reserves has increased from 38 to 67 percent over this period, with the difference strongly influenced by China's reserve accumulation. For these purposes, Taiwan is classified as an advanced country.