Central Banks diversify their holdings into dozens of smaller “non-traditional reserve currencies.”
The share of USD-denominated assets held by other central banks dropped to 56.9% of total foreign exchange reserves in Q3, the lowest since 1994, from 57.1% in Q2 and 58.5% in Q1, according to the IMF’s new data on Currency Composition of Official Foreign Exchange Reserves.
USD-denominated foreign exchange reserves include US Treasury securities, US mortgage-backed securities (MBS), US agency securities, US corporate bonds, and other USD-denominated assets held by central banks other than the Fed.
Excluded are any central bank’s assets denominated in its own currency, such as the Fed’s Treasury securities or the ECB’s euro-denominated securities.
It’s not that foreign central banks dumped US-dollar-denominated assets, such as Treasury securities. They did not. They added a little to their holdings. But they added more assets denominated in other currencies, particularly a gaggle of smaller currencies whose combined share has surged, while central banks’ holdings of USD-denominated assets haven’t changed much for a decade, and so the percentage share of those USD assets continued to decline.
As the dollar’s share declines toward the 50% line, the dollar would still be by far the largest reserve currency, as all other currencies combined would weigh as much as the dollar. But it does have consequences.
Why is having the top reserve currency important for the US?
Foreign central banks buying USD-denominated assets, such as Treasury securities, helps push up prices and push down yields of those assets. Being the dominant reserve currency had the effect of helping the US borrow more cheaply to fund its huge twin deficits – the trade deficit and the budget deficit – and thereby has enabled the US to run those huge twin deficits for decades. At some point, this continued decline as a reserve currency, as it reduces demand for USD debt, would make the trade deficit and the budget deficit more difficult to sustain.
The dollar’s share had already been below 50% before, in 1990 and 1991, after a long plunge from the peak in 1977 (share of 85.5%). This plunge accompanied a deep crisis in the US with sky-high inflation and interest rates, and four recessions over those years, including the nasty double-dip recession. Central banks lost confidence in the Fed’s willingness or ability to do what it takes to get this inflation under control that had washed over the US in three ever larger waves.
The dotted line in the chart below indicates the 50%-share. The dollar’s share bottomed out at 46% in 1991, by which time the Fed had brought inflation under control, and soon, central banks began loading up on dollar-assets.
... continue reading