The Dollar as a Reserve Currency: Apres le Deluge

Time to review trends in reserves, against the backdrop of financial crisis, recession, and dollar gyrations. (I’ll try to be original, but Brad Setser has been more diligent than I in covering these issues over the past few months. [0] [1] [2])

A few observations:

  • Known dollar reserves as a share of world reserves appear to be falling.
  • Total dollar reserves have likely not declined as precipitously.
  • Even with the decline in the dollar share, it is probably not as low as it was during the early 1990’s.
  • The dollar share is (mechanically) linked to the dollar’s value.
  • Known dollar reserves at end-2008 are less than predicted by a historical correlation.
  • But this differential is infinitesimal compared to the “unallocated” share of total reserves.

Consider first the IMF statistics on known dollar, euro (and euro legacy), and pound reserves.


Figure 1: US dollar (blue), euro (red), sum of Deutsche mark, French franc, Dutch guilder, ECU (purple), and British pound (brown) shares of total reserves. NBER defined recession dates shaded gray. Source: IMF, COFER, March 31, 2009, NBER and author’s calculations.

Figure 2: US dollar (blue), US dollar plus 60% of unallocated reserves (green), and IMF-estimated shares of total reserves (chartreuse triangles). NBER defined recession dates shaded gray. Source: IMF, COFER, March 31, 2009, and Chinn-Frankel (2007), NBER and author’s calculations.The triangles denote IMF-estimated holdings of US dollars. Before the COFER database was publicized, the IMF estimated aggregate currency holdings, guessing the portfolio of central banks that did not report the currency composition of their holdings. These figures were reported in the Annual Reports. Notice that the 2004 estimate pretty closely matches the guess that I make, namely that 60% of unallocated holdings are in US dollars. There is, of course, no guarantee that this proportion still holds.

Figure 3: US dollar (blue, right scale), US dollar plus 60% of unallocated reserves (green, right scale), and nominal value of US dollar against major currencies (red, left scale). NBER defined recession dates shaded gray. Source: IMF, COFER, March 31, 2009, Federal Reserve via FREDII, NBER and author’s calculations.Why has the dollar’s share declined? Some proportion is likely due to the decline in the value of the dollar, since the calculation of the value of reserves is made using exchange rates. Of course, a decline in the share is not required, since central banks could be optimizing by keeping the currency shares constant.

Each one percent decline in the dollar’s value is associated with a 0.91 percent decrease in the dollar value of US dollar reserves in the period up to 2008Q2. Based upon this historical correlation, the share of US dollars in total holdings should have been about 2.7 percentage points. Of course, this is small compared to the 37.2 percentage points of total reserves that are unknown in terms of currency composition.

That all being said, we want to be wary of what is coming down the pike. Brad Setser has a good review of possible triggers of a dollar currency crisis, that covers similar ground that I have: [2] [3] [4].

Originally published at Econbrowser and reproduced here with the author’s permission.

5 Responses to "The Dollar as a Reserve Currency: Apres le Deluge"

  1. Wilson   June 16, 2009 at 2:15 pm

    Do we not find it absurd that we are using a reserve currency that has no fundamental assets to back it up?The word Reserve implies something of substance that can be used in times of need.It seems like the real reserve that is left for any reserve is the dwindling reserve of “pure faith” in the US currency.Not here to talk down the US$ or what, but the more one thinks about it, the more shocking it becomes.If you think of something of reserve, it should be of great strength, wealth, and substance.The current Bretton Woods of default mode is a dangerous game and the whole world has been forced in playing with it.When one looks into dictionary for the application of the word reserve:1. Reserve army ( you would picture great lines of army strong and well equipped. Not old and naked)2. Food for reserve in times of need( you would picture lots of food ready for in time of need)3. Stocks of supplies of reserve ( you know what)Now picture this:Reserve Currency (US Dollar)What is US dollar? A currency(a promissionary note or bond) which has defaulted on its gold obligations). And has no substance it in.Can anyone write something factual to calm my nerve? Please don’t tell me it is the world’ most liquid asset therefore it is good. Because No Shxt sherlock, and that is why it is terryfying.Great research by the author though. Writing this so to look for people to write something factual to calm one’s nerve.

    • devils advocate   June 16, 2009 at 2:45 pm

      excellent comments———Dr. Chinnplease focus on the here and nowGovt leaders around the world – led by China – are demanding control beforethe US Dollar is out of control…the USA screwed upit’s for everyone’s good to bring the US Dollar under controlbecause we all depend on it but are moving away from iteach day…today, BRIC will buy each other’s bonds…Japan’s opposition party is leading by 10+% in the pollsand just won a landslide local victory -they demand that US Debt be denominated in YENChinese businesses will accept only a limited amountof US Dollarsthe psychology and overwhelming world move to stabilize the dollarreeks of fear

  2. JohnH   June 16, 2009 at 10:57 pm

    One of the things that has been flying under the radar is that more and more countries are doing business with each other without intermediation of reserve currencies. Brazil and China recently agreed to accept each others’ currencies for commercial transaction. Morocco and Tunisia are working on the same thing, and intend to facilitate currency exchange among all North Africa countries without Euro intermediation.You have to wonder what took them so long?

  3. Anonymous   June 17, 2009 at 4:29 am

    The issue really is the yield on T bonds, notes and bills. The share of $ in world reserves cannot be directly modified, as it is the residual of the cumulated flows of funds (current account deficits and net foreign direct investment and portfolio investments). OTBE, so far the main action to reduce dollar reserves (held by central banks) has been to transfer part of those to Sovereign funds that invest in assets other than US sovereign debt, but if they buy non US assets the effect is negligible. Seems that resource poor emerging countries are trying to reduce their surplus by building up stocks of commodities, but they buy mostly from countries that already have sizeable $ reserves and current account surpluses, so again doesn’t change much the global picture (except in the case of Australia perhaps). There aren’t many buyers of US assets such as land, real estate or companies, the risk being higher than with sovereign debt.

    • devils advocate   June 17, 2009 at 7:52 am

      could you please explain the possible exception of Australia-thanks