Misinterpretations of New Data on International Reserves

The posting by the International Monetary Fund (IMF) of the latest data on the currency composition of international reserves (COFER) as of the end of 2014 brought some overheated reactions by investment banks and the media. J.P. Morgan, for example, focused on what it said was the euro allocation hitting the lowest level since 2002 while the US dollar share climbed to the highest since 2009. The Financial Times said the dip in dollar and euro shares of reserves throws doubt on the ability of emerging markets to keep buying US and European debt. Most of their analysis is nonsense.

It is true that the US dollar's share of the reserve holdings of all those countries that reported their reserves, which hold only 52 percent of total reserves, is back to where it was at the end of the second quarter of 2009 at 62.9 percent. This is up from 62.4 percent at the end of the third quarter of 2014.¹ (See table, first and third columns.) It is also true that the euro's share declined to 22.2 percent from 22.6 percent. However, more than this entire decline, which was not very large, reflected the effects of change in the euro-dollar exchange rate. When non-US dollar holdings at the end of the third quarter are adjusted for the influence of the dollar's appreciation over the fourth quarter, the dollar's share actually declined from 63.3 percent at the end of the third quarter. (See the second column in the table.) The euro's share rose slightly. Stripped of valuation effects, the euro's share holdings of emerging-market and developing countries as a group did decline, but the dollar's share also declined. For the advanced countries as a group, the dollar's exchange-rate-adjusted share declined, and the euro's share actually rose slightly.

Why did the euro's adjusted share in the reserves of advanced countries rise? Because the Swiss National Bank was intervening heavily to prevent the Swiss franc from rising relative to the euro, a policy abandoned early in the first quarter. The Swiss National Bank invests disproportionately in euro-denominated assets.

Why did the US dollar's share in all reserve holdings, as well those of each subgroup, decline? Because the dollar is the intervention currency of most countries and, during the fourth quarter, a number of countries were buying their own currencies with US dollars to slow the depreciation of their currencies against the US dollar.

Emerging-market and developing countries—as well as Hong Kong, Korea, Singapore, and Taiwan, which are classified as advanced countries in the COFER data—may or may not be slowing their accumulation of reserves. Such a trend should be welcomed as removing a symptom of global imbalances—not feared as a threat to the growth of the traditional advanced countries. Global growth depends on the total world saving, not the growth in holdings by one investor of a particular class of assets.

Finally, what about the clamor that China's renminbi is on the verge of becoming an important reserve currency, which was mentioned by J.P. Morgan in the citation above? China's currency may become an important international currency used to denominate trade and investments long before it becomes an important reserve currency. This is because official investors tend to follow behind private sector investors. Moreover, as a simple matter of arithmetic, the renminbi has a long way to go before it achieves the status of an important reserve currency. The COFER data now identify reserve holdings in five currencies other than the US dollar and euro (Japanese yen, pound sterling, Canadian dollar, Australian dollar, and Swiss franc, in order of size of reported holdings). The category of other unspecified currencies, including the renminbi, was only 3.1 percent of total reported holdings at the end of 2014. Unreported holdings were $5.5 trillion. But $3.8 trillion was China's own reserves, by definition not held in renminbi assets. Consequently, if the share of reserve investments in other currencies for nonreporting countries other than China were the same as for reporters and if the renminbi were the only other currency, renminbi holdings would be a mere 2.1 percent of the total at the end of 2014 and more likely less than half that amount.

Note

1. The US dollar share of international reserves at the end of the second quarter of 2009 as well as at the end of the first quarter that year were strongly affected by the effects of the strong dollar as described in the text for the end of 2014.