Numbers newly reported from the IMF’s COFER data base show that in the most recent quarter, the spring of 2009, the share of central banks’ foreign exchange reserve holdings that they allocate to dollars resumed its downward trend. The dollar share has been gradually sliding since the beginning of the decade – perhaps because of the birth of a possible rival, the euro, in 1999, or perhaps because of the long-term path of tremendous fiscal and monetary expansion on which the United States embarked in 2001.
During the four quarters preceding the most recent one, the share of the aggregate portfolio that the world’s central banks allocated to dollars had temporarily reversed its downward direction. Arithmetically, the main source of this increase in the dollar’s share was its appreciation against other currencies. But another source was the action of central banks in industrialized countries, acquiring dollars more rapidly than other currencies. The movement of the raw quantity shares can be seen in the first graph below, and the movement in the shares properly valued at current exchange rates in the second graph. (I am grateful to Ted Truman and Dan Xie, both of the Petersen Institute for International Economics, for these graphs.)
Whether the temporary reversal from Q2 of 2007 to Q1 of 2008 is measured in quantity terms or in valuation terms, the phenomenon was presumably a (surprisingly strong) safe-haven reaction to the global financial crisis. Apparently the recent easing of risk and liquidity concerns has now mitigated the flight into dollars. The central banks that had shifted into dollars have begun to shift back a bit, into euros in particular.
The gradual downward trend of the dollar’s share during the past decade is a continuation of the trend that began after the end of the Bretton Woods system: from the late 1970s until 1991. The dollar’s share recovered from 1992 to 2000. That temporary halt in the longer run trend may have been in part a result of the deficit reduction path that began with George H.W. Bush’s unpopular fiscal reversal and continued through the time of Bill Clinton achievement of fiscal surpluses, until George W. Bush took office and reinstated the chronic deficits.
The usual response to worries that US macroeconomic profligacy will eventually end the dollar’s privileged position as lead international currency has always been that no asset constitutes a credible alternative for central banks to hold in their portfolios. I have argued that, since 1999, the euro has constituted a credible alternative. Based on econometric estimates of the determinants of central banks’ reserve holdings in research with Menzie Chinn, we have even gone so far as to report simulations that show the euro overtaking the dollar by 2022. Many, like Truman, consider such speculation exaggerated. They may be right.
But the euro is not the only alternative to the dollar. The yen, pound and Swiss franc remain viable alternatives for national authorities to put some of their reserves. Furthermore, 2009 has seen the resurrection of two international reserve assets that had previously been written off as dead: the SDR and gold. My forecast is that we are gradually moving from the dollar standard to a global monetary system that features multiple reserve assets.
Share of central banks foreign exchange reserves allocated to dollars, 1999 QI – 2009 QII (among industrial countries, among developing countries, and overall)
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