Column-Demise of dollar’s FX reserve omnipotence greatly exaggerated: McGeever
2024.06.06 11:04
By Jamie McGeever
ORLANDO, Florida (Reuters) – After two decades of the dollar’s share of global foreign exchange reserves gradually eroding to less than 60%, economic, financial and geopolitical stars are aligning to halt that trend in the next few years and possibly even reverse it.
At least temporarily.
That’s the indication from an annual survey of central banks and reserve managers conducted by the Official Monetary and Financial Institutions Forum, which chimes with recent research and analysis from leading figures in the world of FX reserves.
The emergence of the euro and China’s explosive rise to the world’s second-biggest economy have diminished the dollar’s FX reserve status, and an ongoing desire for diversification is likely to ensure it is never quite as omnipotent again.
But according to the OMFIF’s ‘Global Public Investor 2024’ survey of 73 central banks in charge of managing $5.4 trillion of reserves, a net 18% of reserve managers plan to increase their dollar holdings over the next 12-24 months.
That’s two and a half times more than the second-highest currency, the euro, which a net 7% of respondents plan to increase exposure to.
Perhaps more significantly, it is three times higher than the net 6% in last year’s survey who said they would raise their dollar share. That’s a hugely positive swing in sentiment.
DISTANT LAGGARDS
The dollar continues to enjoy overwhelming dominance in international trade, invoicing and financing flows, and U.S. debt markets offer a depth of liquidity that no market on the planet comes close to matching.
OMFIF’s ‘Global Public Investor 2024’ survey found that 27% of reserve managers say the most important investment objective this year is ensuring liquidity, up from 20% last year.
On top of that, cyclical factors are increasingly playing into the dollar’s favor – U.S. economic growth and rates of return relative to global peers are high and look likely to remain so over the next couple of years.
This would signal a shift in central bank thinking. In a May 29 post, New York Fed economists argue that relative returns on sovereign assets have not been a significant factor in the dollar’s share of official reserves.
What the OMFIF survey, New York Fed and other analysis all point to is the rise in global geopolitical tensions and need for liquidity, which will draw reserve managers to the dollar more than any other currency.
“For the dollar share to fall, another currency’s share has to rise. Then you have to question, which one? Which of the others is a truly global currency,” said Hiro Ito, professor of economics at Portland State University and a renowned authority on global FX reserves and capital flows.
“The dollar’s dominance is so strong. There’s no most powerful second currency, and certainly no most powerful third, fourth, or fifth currency,” he says.
SANCTIONS
While debate around the dollar’s FX reserves status is often conflated with doomsday scenarios about the collapse of the U.S. currency and economy, much less is said about the euro’s failure to capitalize on the gradual erosion of the dollar’s dominance.
According to the International Monetary Fund’s composition of official exchange reserves (Cofer) data, the euro’s share of the $12 trillion total last year was just under 20%, exactly where it was in 2015 and well down from its peak of 28% in 2009.
Geopolitics must be on central banks’ minds here too.
The freezing of Russian assets and sanctions on Russia after it invaded Ukraine will affect the euro more than the dollar – Moscow had sold all its U.S. Treasuries and greatly reduced the dollar share of FX reserves before the invasion, and most Russian money overseas is in Europe, not the United States.
Equally, if freezing Chinese assets abroad is a possibility, will countries in Asia – or anywhere, for that matter – want to be exposed to the renminbi? That’s before China’s capital controls are even taken into account.
SMALL COHORT, BIG IMPACT
A New York Fed paper in March found that countries that are more politically distant from the United States, and perhaps more likely to be subject to financial sanctions, tend to have a higher dollar share in official reserves, all else equal.
It is countries that already have large reserves, well in excess of emergency liquidity needs and already with a high dollar share, that are more liable to divest out of dollars on geopolitical grounds.
According to the March research, the seven percentage point decline in the dollar’s share of global reserves between 2015 and 2021 was driven by a small group of countries – notably China, India, Russia, and Turkey – and the large increase in Switzerland’s euro reserves accumulated through FX intervention.
“It is therefore not the case that countries are moving away from dollars en masse,” they write, adding that out of the 55 countries for which there are estimates, 31 increased the dollar share of reserves in that period.
(The opinions expressed here are those of the author, a columnist for Reuters.)
(By Jamie McGeever; Editing by Andrea Ricci)
