For years, central banks around the world have held most of their foreign currency reserves in U.S. dollars. Now, there are signs that central banks are shifting away from dollar assets and into other currencies, such as euros. That’s mainly because the dollar’s value has fallen so much in the past three years. Experts say the gradual shift away from the U.S. currency is likely to continue — suggesting there’s more dollar weakness ahead.
PRAGUE – It began with Russia. Over the past few years, the Russian Central Bank has reduced the share of dollars in its foreign currency reserves, and has made no bones about it. Then Indonesia said it, too, was considering such a move. This week, Bahrain’s central bank governor said the euro is increasingly emerging as an international reserve currency. And reports the very next day – though later played down – suggested that South Korea planned to sell some of its dollar holdings to “diversify” its currency reserves. Korea is the world’s fourth-largest holder of dollar reserves after Japan, China and Taiwan.
Ashraf Laidi, a currency analyst in New York, said it’s clear why “diversification”, a trend by countries to hold more of their reserves in currencies other than the dollar, is a hot topic now. “This talk is really part of central banks’ growing unease with holding on to a currency that has lost approximately 30% of its value over the last three years. It makes sense to hold on to something that doesn’t lose its value, doesn’t it?” Laidi said.
Experts say it’s difficult to say with certainty to what extent the shift is under way. Central banks often don’t give out such information. But a survey last month by Central Banking Publications showed many central banks have increased the share of their reserves held in euros. They may not be actually selling dollars – just buying fewer dollar assets, such as United States government bonds, and more bonds denominated in other currencies. That’s bad enough news for the dollar.
Laidi said it’s a gradual shift. “Russia two years ago started off with nearly 90% holdings in US dollars. Today that proportion has fallen to below 80%. And some central banks are either considering or making some moves in that direction. Many central banks don’t disclose the exact denomination in which currencies they have foreign exchange reserves. But currency traders have reasons to believe the move is under way, albeit in a gradual manner.”
To be sure, not all players are diversifying. Japan, the biggest foreign holder of US bonds, said on Thursday that it has no plans to increase the share of euros in its reserves. But experts say any shift is important. One reason is that when central banks sell large amounts of dollars, the dollar loses value in the foreign currency exchange market. So any sign that the biggest customers – central banks – are curbing their enthusiasm for US dollar assets is bad news for the greenback.
Gianluca Benigno from London School of Economics said the trend is likely to continue. “The euro is an alternative reserve currency that central banks believe is becoming more liquid and important,” he said. “The issue is likely to get more pressing in the next few months. It started to create ripples months ago when Russia began to release news about its diversification strategy. There will probably be similar news in the next few months.”
As Benigno noted, the shift also reflects the rising importance of the euro. So could the dollar lose its status as the world’s chief international currency? Experts say it’s possible the euro will at some point rival the dollar. But Malcolm Sawyer, an economics professor at Leeds University, said that’s still a long way off. “I can see a time, maybe 10-20 years hence, when the euro and the dollar will have equal status, but I think that is really some time off,” Sawyer said. “We are still in a position where much trade is financed through dollars and many things like oil are priced in dollars, which is also widely accepted in many countries in the world. So I think that for a long time, the preeminence of the dollar will continue, although given the euro’s rise, it won’t be quite as preeminent as it has been.”
For US exporters, however, a weak dollar has been a welcome boost. “The biggest winner is obviously the US manufacturing sector because it’s experiencing a huge gain in competitiveness as the dollar sinks against the euro,” said Robin Bew, chief economist at the Economist Intelligence Unit in London. Among the winners are consumers from countries whose currencies have strengthened against the dollar. They’re finding US products and holidays much cheaper.
On the other hand, exports of the eurozone have suffered considerably because of dollar’s steady decline. French winemakers rallied in December to draw attention to their industry’s problems, including a falling dollar that makes their bottles pricier in the lucrative US market. Bew said many eurozone companies have seen their profits fall as they cut prices to compete with cheaper US products.
In recent months, several European policymakers have complained about the rise of the euro against the dollar. It has raised the question of intervention – when central banks sell or buy currency to influence the exchange rate level. French Finance Minister Herve Gaymard warned in December of a possible “economic catastrophe” unless the US, Europe, and Asia work together to stop the dollar’s fall. Some Asian banks have intervened to keep their currencies from strengthening. But experts say there’s little likelihood of international coordinated intervention. That’s because the US, they say, despite official rhetoric to the contrary, is happy to see the benefits of the dollar’s slide – as long as it’s gradual.
Copyright (c) 2005, RFE/RL Inc.