Central Banks Diversify Reserves as US Dollar Share Hits 30-Year Low

January 6, 2025

The global financial landscape is undergoing a significant transformation as central banks around the world diversify their reserves away from the US dollar. This shift is driven by a combination of historical precedents, economic policies, and the pursuit of stability in an increasingly volatile market. The US dollar, while still dominant, is losing ground to other currencies and assets, signaling a move towards a more multipolar reserve currency system. This evolution in reserve management strategies underscores a growing trend towards diversification and risk mitigation in the face of global economic uncertainties.

The decline in the US dollar’s predominance in the reserves of central banks has been steadily increasing over several years. As of the third quarter of 2024, the USD’s share dropped to 57.4%, a level not seen since 1994. Over the last decade, from the first quarter of 2015 to the third quarter of 2024, the USD’s share fell from 66% to its current figure, marking an 8.6 percentage point drop. Should this trend continue at the same pace, it is anticipated that the dollar’s share might dip below 50% by 2034.

Decline of the US Dollar as a Reserve Currency

The decline in the share of US dollar-denominated foreign exchange reserves is not unprecedented. Historical data reveals that the US dollar experienced a significant dip between 1977 and 1991, dropping from 85% to 46%. This tumultuous period was characterized by high inflation in the United States, which eroded global confidence in the Federal Reserve’s ability to manage inflation effectively. However, the 1990s saw the dollar surge back in prominence, bolstered by economic reforms and a stabilizing US economy, until the introduction of the euro began to challenge its dominance.

The current downward trend differs from historical patterns due to the contemporary global economic landscape. Today’s central banks are more informed and have access to a wider array of currencies and assets, allowing them to diversify with greater precision. By analyzing these fluctuations, financial analysts can better understand the directions and underlying motivations of various global reserve strategies. Moreover, this ongoing shift towards a more balanced basket of reserves marks a significant departure from the past’s heavy reliance on the US dollar.

Current Holdings and Diversification

Central banks worldwide collectively hold a substantial $12.7 trillion in foreign exchange reserves. A considerable portion of these assets, amounting to $6.77 trillion, are denominated in US dollars. Following the USD, euro-denominated assets constitute $2.37 trillion, yen-denominated assets stand at $0.69 trillion, and GBP-denominated assets at $0.59 trillion. Interestingly, despite the overall decline in the US dollar’s share, foreign holdings of US Treasury securities have seen an uptick, reaching a record high of $8.67 trillion, representing an $880 billion increase over the past 12 months.

This apparent paradox can be attributed to the central banks’ active diversification strategies. They have been increasingly channeling their reserves into other currencies and more diverse asset classes. This move is driven by the necessity to mitigate risks associated with holding a large proportion of reserves in any single currency. The growing liquidity of nontraditional currency assets and the pursuit of higher-yielding assets during periods of low interest rates in the US and Europe have also been significant influencing factors in this trend.

Emergence of Other Reserve Currencies

As central banks continue to diversify their reserves, the euro has emerged as the second-largest reserve currency, seeing a marginal increase to a 20% share. This stability highlights the euro’s role as a credible and significant alternative to the US dollar. Concurrently, there has been a notable rise in the share of “nontraditional reserve currencies,” which collectively have increased their presence in global reserves since 2020. This group of currencies includes several smaller currencies that have gradually gained traction at the expense of the USD’s dominance.

The Chinese renminbi (RMB), introduced into the International Monetary Fund’s Special Drawing Rights (SDR) basket in 2016, remains a relatively minor player in the overall reserve currency landscape. Recently, even the RMB was surpassed by currencies such as the Australian dollar (AUD) in terms of reserve holdings. This indicates a growing acceptance and recognition of a more diverse array of currencies within central bank reserves, pointing towards a broader trend of adoption and utilization of different currencies in the global financial system.

Central Banks’ Diversification Strategies

The International Monetary Fund identified 46 central banks that actively diversified at least 5% of their reserves into nontraditional currencies. These central banks span across G20 economies, reflecting a broad-based shift in reserve management strategies across different regions. The primary motivations for this diversification include the growing liquidity of assets denominated in nontraditional currencies and the pursuit of higher-yielding investments during periods of low interest rates in the US and Europe, offering an attractive alternative to conventional reserve assets.

Institutions are adopting an increasingly risk-averse stance, preferring diversified portfolios to safeguard against potential volatility in the US dollar. This strategic approach aims at enhancing the stability and resilience of their reserves amidst global economic uncertainties. Diversifying into nontraditional currencies is a calculated move to reduce over-reliance on the US dollar and spread risk across a broader range of assets. This strategy not only mitigates risk but also positions central banks to capitalize on a range of opportunities presented by the dynamic, global financial market.

Gold Reserves

Central banks have been increasing their gold holdings following decades of reduction. Over the past decade, gold reserves have surged to 1.16 billion troy ounces, valued at approximately $3.08 trillion. This resurgence in gold holdings underscores the metal’s enduring appeal as a safe-haven asset in times of economic uncertainty.

The renewed interest in gold can be seen as part of a broader strategy to diversify away from fiat currencies and into tangible assets, safeguarding economic futures against potential market volatility. Gold’s historical role as a store of value, alongside its relative stability compared to other currencies, makes it an increasingly attractive option for central banks looking to bolster the security and stability of their reserves. This trend indicates that gold is likely to remain a significant component of central bank reserves as they seek to enhance their economic resilience and security.

Impact of USD Exchange Rates

The global financial environment is experiencing a major shift as central banks worldwide diversify their reserves away from the US dollar. This change is propelled by a blend of historical trends, economic policies, and the quest for stability in a volatile market. Although the US dollar remains influential, it is gradually ceding ground to other currencies and assets, hinting at a transition towards a more multipolar reserve currency system. This development in reserve management highlights a significant trend towards diversification and risk reduction amid global economic uncertainties.

The US dollar’s dominance in the reserve holdings of central banks has been waning over the past several years. By the third quarter of 2024, the USD’s share had declined to 57.4%, a level last observed in 1994. From the first quarter of 2015 through the third quarter of 2024, the dollar’s share decreased from 66% to its current percentage, showing an 8.6 percentage point drop. If this trend persists, the dollar’s share may fall below 50% by 2034, highlighting a potential shift in the global financial system’s dynamics.

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