There’s a ‘stealth erosion’ in global US dollar reserves, but there’s no dominant replacement yet

The dollar has been strengthening against most currencies in recent years — indicating that private investors have moved into dollar-based assets. This effect masked the shift of central banks and governments out of dollar reserves.

The Dollar Index, which measures the value of the greenback against a basket of foreign currencies, has gained 4% this year to date and about 7% since March 2022, when the US Federal Reserve started its last interest-rate hike cycle.

Central banks have been ‘shifting gradually’ away from the USD

The dollar’s share hasn’t been overtaken by the world’s other three major currencies — the euro, the Japanese yen, or the UK pound sterling.

Instead, the shares of “non-traditional reserve currencies” have risen, according to the IMF. These include the Australian dollar, Canadian dollar, Chinese renminbi, South Korean won, Singaporean dollar, and Nordic currencies.

The IMF’s findings are consistent with its previous report in 2022 when it found that the dollar’s dominance was waning and getting replaced with alternative currencies.

“These nontraditional reserve currencies are attractive to reserve managers because they provide diversification and relatively attractive yields, and because they have become increasingly easy to buy, sell and hold with the development of new digital financial technologies,” wrote IMF’s economists in their latest report, which is based on data from 149 reporting economies that collectively account for 93% of global forex reserves.

The dollar’s decline in FX reserves doesn’t appear to be about sanctions

The IMF’s report comes amid ongoing discussions about de-dollarization.

With the use of sanctions, the West effectively shut Russia out of the global, greenback-based financial system after Moscow started the war in Ukraine.

Other countries are now concerned that they, too, could be locked out of the US dollar-based financial system.

However, the slow waning of the dollar’s dominance in global forex reserves appears to be less about trade restrictions than diversification — because its decline has not accelerated in recent years despite the US’ intensifying use of financial sanctions.

Even so, there are other concerns that may erode confidence in the greenback, analysts have said recently.

On Monday, two American think tank analysts wrote in the Financial Times that “American dysfunction” — political and fiscal — is the real threat to dollar dominance. This sentiment was also echoed by Jared Cohen, the president of global affairs at Goldman Sachs, in Foreign Policy.