US dollar loses shine as reserve currency for emerging economies

Nihon Keizai
US dollar loses shine as reserve currency for emerging economies

The share of U.S. dollar-denominated assets in the world's foreign reserves sank for the fifth straight year in 2020 to 59%, its lowest level in a quarter century, as emerging economies like China and Russia diversify holdings amid concerns over the greenback's prospects. As Nixon Keizai writes, as a trusted and liquid asset, U.S. government bonds have long been a go-to option in foreign reserves, which governments and central banks maintain as a backup fund of sorts in case of a monetary emergency.

But data from the International Monetary Fund suggests the dollar may be starting to lose its draw as a reserve currency. As the coronavirus exacerbates the so-called twin deficit in the U.S., casting doubt over the dollar's long-term value, authorities around the world are starting to place more weight on assets in alternative currencies as well as nonmonetary options like gold.

According to a tally of 149 countries and regions by the IMF, global foreign reserves totaled $12.7 trillion at the end of 2020. Dollar-denominated assets in particular increased 4% to $7 trillion.

"This is partly because emerging economies intervened in the market by offloading their home currencies for the dollar, so they could keep their currencies from strengthening and squeezing their exports," said Daisuke Karakama, chief market economist at Japan's Mizuho Bank. The U.S. had also issued more government bonds to fund large-scale coronavirus stimulus measures.

But as a percentage of allocated foreign reserves, dollar-denominated assets fell 1.7 points to 59% as of the end of 2020. It last fell below the 60% mark in 1995.

Dollar assets made up more than 70% of global reserves at the end of 2001, but have since been trending down.

A weaker dollar in 2020 was a contributing factor to the currency's decline in share last year. Still, "taking a longer view, the fact that the value of the U.S. dollar has been broadly unchanged, while the U.S. dollar's share of global reserves has declined, indicates that central banks have indeed been shifting gradually away from the U.S. dollar," Serkan Arslanalp and Chima Simpson-Bell, two IMF economists said in an IMF Blog post.

China held $1.07 trillion in U.S. government securities at the end of 2020, according to the U.S. Treasury Department -- down almost 20% from its peak seven years ago. "Most of China's Treasury holdings are part of its foreign reserves," said Kota Hirayama, senior economist at SMBC Nikko Securities.

Some market watchers believe Chinese sales of U.S. bonds are starting to settle following the inauguration of U.S. President Joe Biden.

Russian holdings are plunging as well. Russia's international reserves including gold totaled $578.7 billion as of September, according to data released by its central bank. Dollar-denominated assets made up roughly 20% of this tally, down from about half in 2017.

Russia began dumping dollar assets after the U.S. imposed economic sanctions on the country for its annexation of Crimea. Turkey and Brazil have also been shifting away from U.S. government bonds in recent years.

Instead, countries are turning to nondollar assets. Euro-denominated assets made up 21% of global allocated reserves at the end of 2020, according to the IMF, recovering to where they were six years prior. Some market watchers believe the euro has risen in popularity after the European Union issued common bonds on behalf of all of its members to fund its coronavirus response.

Yen assets rose above the 6% mark for the first time in two decades. Chinese investors bought a net 2.2 trillion yen ($20.2 billion) of Japanese medium- to long-term bonds in 2020, a potential sign that the country is converting some of its dollar-denominated holdings into yen.

The yuan is gaining traction as well, topping 2% of global allocated reserves. The Chinese currency has made rapid headway in Russia, in particular, where its share in international reserves rose to 12.3% as of September from 0.1% in June 2017.

Gold, the value of which is not tied to any governments, is also gaining more traction. Central banks have been net buyers of gold for the past decade, according to the World Gold Council.

Gold overtook U.S. dollars as a proportion of Russian international reserves last year. The Hungarian central bank in March also tripled the amount of gold in its foreign reserves to 94.5 tons, saying that "the appearance of global spikes in government debts or inflation concerns further increase the importance of gold in national strategy as a safe-haven asset."