The prominence of the US dollar as the world’s dominant currency – often referred to as dollar dominance – has become a central topic in recent global economic discussions. Factors such as the robust US economy, tighter US monetary policy, and escalating geopolitical uncertainties have all contributed to a stronger valuation of the dollar. Simultaneously, growing concerns about economic fragmentation and the potential formation of distinct global economic and financial blocs are prompting some nations to explore diversifying their holdings into alternative international and reserve currencies beyond the US dollar.
Recent data from the International Monetary Fund (IMF), specifically from its Currency Composition of Official Foreign Exchange Reserves (COFER) database, reveals a continuing, albeit gradual, decline in the US dollar’s share of allocated foreign reserves held by central banks and governments worldwide. Interestingly, this reduction in the dollar’s role over the past two decades hasn’t translated into increased shares for the other traditionally dominant currencies – the euro, Japanese yen, and British pound. Instead, the shift has been towards what are termed “nontraditional reserve currencies.” This category includes currencies like the Australian dollar, Canadian dollar, Chinese renminbi, South Korean won, Singaporean dollar, and the Nordic currencies. The most recent data underscores this ongoing trend, which has been previously highlighted in IMF research papers and publications.
These nontraditional reserve currencies are gaining traction among reserve managers for several compelling reasons. They offer valuable diversification benefits, provide comparatively attractive yields, and crucially, have become increasingly accessible for trading and holding thanks to advancements in digital financial technologies. These technologies include automated market-making systems and sophisticated automated liquidity management tools that streamline transactions in these currencies.
This trend is particularly noteworthy considering the US dollar’s recent strength. Typically, a strong dollar would suggest increased demand for dollar-denominated assets from private investors, as reflected in relative price changes. However, exchange rate fluctuations can independently influence the currency composition of central bank reserve portfolios. Changes in the relative values of government securities, driven by interest rate movements, can also play a role, though this effect is usually less pronounced since major currency bond yields tend to move in tandem. Regardless, these valuation effects only reinforce the broader trend. Looking at the longer term, over the last two decades, the US dollar’s value has remained broadly stable, yet its share of global reserves has decreased, indicating a deliberate and gradual shift away from the dollar by central banks.
Despite claims that US financial sanctions are accelerating a move away from the dollar, statistical analysis does not currently indicate an accelerating decline in the dollar’s reserve share. While it’s argued by some that countries seeking to reduce dollar holdings for geopolitical reasons might not report their reserve composition to COFER, it’s important to note that the 149 economies that do report to COFER represent a significant 93 percent of global foreign exchange reserves. This suggests that non-reporting countries constitute only a minor fraction of global reserves.
The Chinese renminbi stands out as one nontraditional reserve currency that has gained market share, accounting for approximately a quarter of the decline in the dollar’s share. The Chinese government has actively promoted renminbi internationalization through various policies, including developing a cross-border payment system, establishing swap lines, and piloting a central bank digital currency. However, recent data suggests that the renminbi’s internationalization, as measured by its reserve share, may be losing momentum. The latest figures do not show further increases in the renminbi’s currency share. While some speculate that recent depreciation of the renminbi exchange rate might obscure increases in renminbi reserve holdings, even when adjusting for exchange rate changes, the renminbi’s share of reserves appears to have declined since 2022.
Some analysts propose that the observed decline in dollar holdings and the rise of nontraditional currencies is primarily driven by the actions of a few large reserve holders. For instance, Russia’s geopolitical stance might lead it to reduce dollar holdings, while Switzerland’s significant reserve accumulation over the past decade might favor euro holdings due to its geographical proximity and strong trade links with the Euro Area. However, even when excluding Russia and Switzerland from the COFER aggregate, using publicly available data from their central banks from 2007 to 2021, the overall trend of gradual dollar decline remains largely unchanged.
Indeed, this shift is widespread. An IMF study identified 46 “active diversifiers” in 2022 – countries with at least 5 percent of their foreign exchange reserves in nontraditional currencies by the end of 2020. This group includes major advanced economies and emerging markets, notably most of the Group of Twenty (G20) economies. By 2023, at least three more countries – Israel, Netherlands, and Seychelles – have joined this list, highlighting the expanding scope of diversification.
Research also indicates that the imposition of financial sanctions in the past has led central banks to modestly reduce their reserve allocations to currencies perceived as susceptible to freezing or redeployment. Instead, they have shown a preference for gold, which can be stored domestically and is thus insulated from sanctions risks. This research also revealed that central bank demand for gold is positively correlated with global economic policy uncertainty and geopolitical risk. These factors may be contributing to the recent increase in gold accumulation by several emerging market central banks. Nevertheless, it’s crucial to remember that gold’s share of total reserves remains historically low.
In conclusion, the international monetary and reserve system is in a state of continuous evolution. The trends previously identified – a very gradual decrease in dollar dominance and an increasing role for the nontraditional currencies of smaller, open, and well-managed economies, facilitated by advancements in digital trading technologies – are still evident. The Us Money Reserve, while still dominant, is facing a slow but persistent diversification trend in the global financial landscape.
