The latest IMF blog reminds us that the US Dollar's share of global central bank foreign reserves has fallen to 59% at the end of 2020 from 71% in 2000. The IMF estimates that most of the short-term, quarterly, changes in this share can be explained by US Dollar exchange rate changes (appreciation or depreciation). However, over the longer term, eg decades, the erosion of the US Dollar's pre-eminent reserve status due to competition from other, mainly non-Euro, currencies, is also clear.
Reserve currencies tend to have self-reinforcing characteristics. They hail from countries with:
High shares of global trade, investment, finance and invoicing.
Full convertibility and liberalised capital account.
Credible central bank and systemically important banks.
Protection of property rights and a well-established rule of law.
Global geopolitical dominance.
These factors in favour of the US Dollar will, for some time, slow the erosion of its dominant reserve currency status under the threats of its loose monetary and fiscal policy, its increasing use of targeted sanctions, the rise of China, and the growth of cryptocurrencies (particularly when they are backed by central banks).
When the US Dollar is eventually dethroned, the loss of exceptional room for manoeuvre in US monetary and fiscal policy may be a disorderly one for global capital markets. But that may not occur during the professional careers of anyone reading this note. And for most emerging markets, as long as their currency is viewed as relatively risky it matters little which specific currency is the prevailing dominant reserve currency.
Related reading
US Dollar as reserve currency after Covid-19? A moot point for EM ex-China, April 2020
Emerging market currency winners and losers from strengthening dollar (Curran), March 2021