The dollar may still be the
dominant reserve currency hoarded in central bank coffers, but
it does not quite hold the commanding position of yore.
Its share has dropped from 71.5
percent of official forex "allocated reserves" at the beginning
of the 2000s forex reserves whose currency denomination
is known to just over 60 percent today.
In the meantime, though, no single
currency has quite managed to usurp the greenback.
Instead, foreign central banks have
favored a more diversified portfolio, according to IMF data.
The combined share of allocated reserves held by the euro and
dollar has dropped from just above 90 percent in mid-2009 to 87
percent only three years later. Is it possible that central
banks will continue diversifying their forex portfolios
creating a wide range of currencies with an equally good, or
bad, claim to be global reserve currencies?
The IMF numbers do not tell us
which currencies account for this diversification: The
lions share of it comes from the IMFs mysterious
"claims in other currencies" category. This figure, which
excludes sterling, the yen and the Swiss franc, as well as the
dollar and the euro, has quadrupled since late 2007 to $310
billion-worth. The increase in the overall share of allocated
reserves held in "other currencies" has risen over the same
period from only 1.8 to 5.3 percent.
Central banks are diversifying
their currency reserves out of a "prudent desire for profit
maximization," says David Marsh, co-chairman of the Official
Monetary and Financial Institutions Forum (Omfif) in London,
which exists to promote dialogue among government and private
sector financial organizations. Marsh says central banks are
trying to turn their forex reserves into "profit centers."
Private sector investment managers seeking to earn a return
from their portfolios usually choose to diversify, and to an
increasing extent, central banks are no different these days.
"Portfolio diversification theory suggests they should hold a
greater number of currencies," says Marsh.
Which currencies are likely to gain
from this? A little-noticed piece of recent news from the IMF
gave a strong clue to investors as to what the up-and-coming
reserve currencies are. In November it revealed that it was
considering, from next year, requesting and then publishing
data on the central banks forex reserves of Australian
and Canadian dollars a symbolically important move,
which unofficially confers on them the status of reserve
Analysts say the progressive
buildup, in recent months, of forex reserves at the Reserve
Bank of Australia confirms that foreign central banks are eager
to swap their own currency for the aussie. The aussie has even
started behaving like a reserve currency. It has, this year,
defied the usual gravitational forces that apply to normal
currencies: The central banks benchmark rate has been
slashed by 175 basis points (bp) since October 2011, but the
Australian dollar appears profoundly indifferent. On the day of
the latest interest rate cut, a 25bp fall announced last week,
it even rose slightly against the U.S. dollar. At the close of
Asian trading on Wednesday, it was worth US$1.05.
The aussies appeal to central
banks lies partly in the robust, commodity-based growth of the
Australian economy, and partly in the increasingly rare
triple-A status of Australian government bonds the
vehicle preferred by foreign central banks for holding
Analysts say another largely
commodity-based currency gaining a growing following among
central banks is the Canadian dollar, which benefits from
Canadas large net oil exports.
Marsh estimates that official
foreign exchange holdings "probably" total about $60 billion
for each of the two currencies. Although $60 billion is less
than 1 percent of total global reserves, "allocated" and
otherwise, of $10.5 trillion-worth, it is a growing
Diversification makes sense for
positive reasons, but there is also an important negative
reason for its attractiveness: the unattractiveness of the two
conventional reserve currencies, the dollar and euro.
The decline in the dollars
share makes sense given global fears about the U.S.
economys long-term future, say the many analysts who
espouse a declinist view of the country. They see the
dollars recent firmness as unlikely to last. "Because of
continuing U.S. deficits and low domestic savings, the stock of
U.S. debt held by foreigners has become so high that central
banks and other investors are beginning to doubt the
governments ability to pay it back," says John Hummel,
partner, president and chief investment officer of AIS Capital
Management in Wilton, Connecticut. Hummel is bearish about the
The euros bid to be a reserve
currency has, until recently, been aided by fears about the
dollar. When the euro was launched in 1999, it accounted for
18.1 percent of official allocated reserves. By the second
quarter of 2011, the figure was 26.7 percent.
However, the euro has problems too
in the eyes of central bankers not least the fear, ever
since the euro zone fiscal crisis erupted last year, that its
dominion might shrink or disappear altogether as the currency
union disintegrated. Its share had slipped, by the second
quarter of this year, to 25.1 percent.
"The two main currencies accounting
for the bulk of reserves are undoubtedly showing strains," says
Marsh of Omfif. He adds that this is "driving interest in
currencies like the Australian and Canadian dollars."
The greatest long-term threat to
dollar dominance may come from the renminbi, which is not so
much the elephant in the room as the pachyderm slowly lumbering
down the hallway towards it. China has the worlds
second-biggest economy and is predicted, if present trends
broadly continue, to overtake the U.S. to clinch the top spot
within the next ten years. However, the renminbi can never
become a reserve currency unless its strict capital controls
are relinquished, allowing it to be bought and sold freely
a process that is likely to take several years at the
very least. It is also possible that the ruling Communist party
will remain forever reluctant to allow a fully convertible
renminbi, because it would greatly reduce the partys
power to direct the economy as it sees fit.
With the euro and renminbi burdened
by their own particular flaws as reserve currencies, central
banks wary of excessive U.S. dollar dependence are likely to
continue looking at smaller currencies particularly, but
not exclusively, those buoyed by commodity-based underlying
economies. In addition to the Australian and Canadian dollars,
Marsh says that a small number of central banks also hold the
Korean won and Singapore dollar, for example.
However, analysts say that although this trend is likely to
continue chipping away at the dollars share of total
reserves, the unsuitability of the euro and renminbi are likely
to keep the dollars decline as a reserve currency gradual
rather than dramatic.