The most striking statistic in OMFIF’s 2026 Global Public Investor is that not a single central bank surveyed forecast that they would be reducing foreign exchange reserves in coming years, underlining the point that central banks around the world have a preference for allowing foreign exchange reserves and gold reserves to increase. This is a reality that John Nugée and I discussed in an OMFIF white paper as long ago as 2016.
This appetite for more reserves is despite the fact that many nations already have quantities that exceed traditional International Monetary Fund measures of reserves adequacy. The experience of crises going back decades helps to explain why, but a debate is needed on how central banks can best balance the challenges that they face over holding large quantities of reserves.
The GPI survey also highlighted that central banks are reluctant to use their reserves. In the event of a crisis, over 50% of respondents would be reluctant to spend more than 10% of reserves. This confused situation (wanting more reserves but having low appetite to deploy them) has been a global trend that began with the UK sterling crisis of 1992 and gathered pace during the Asian crisis of the late 1990s. It is now embedded.
The role of the dollar in FX reserves
FX reserves are a national safety net. They are the water trough that every horse will expect to drink from in the event of a crisis. The list of potential tasks that reserves might be expected to underwrite only ever grows, a trend that was accentuated by fallout from the 2008 financial crisis and the Covid-19 pandemic.
Because the nature of the next crisis is unknown, the size of the required safety net cannot be defined. Because there are now so many horses that might want to visit the trough, central banks can’t take the risk of providing large resources to fight the first crisis because another crisis might be just around the corner.
The OMFIF survey revealed that the only currency that FX reserve managers as a group were planning to reduce exposure to was the dollar. There is no real surprise here: the dollar’s share of FX reserves as measured by the IMF’s Currency Composition of Official Foreign Exchange Rates data has been declining slowly for around 25 years, from around 70% of global share to 57% currently. When asked what they expect the weight of the dollar to be in 10 years’ time, reserve managers’ average response was 50%. I agree.
The point is that, even with a reduced weight of 50%, the dollar will still dominate the FX reserves allocations. Such a weight will still be significantly bigger than that of the euro (currently around 20%) and the renminbi (around 2%). Simply put, the starting point for a discussion on the dollar’s share in FX reserves cannot be separated from the fact that the US currency is the centre of gravity for the international monetary system.
Why will the dollar’s share decline?
The weaponisation of the dollar, which gathered pace in the wake of the 2001 terror attacks on the US, has encouraged the decline in the dollar’s share in FX reserves. The Patriot Act was designed to combat the financing of terror activities but has morphed into a flexible tool for implementing US national security objectives.
On the one hand, the US is in the enviable position of being able to use financial assets to achieve foreign policy goals but, on the other hand, the more it is used in this way, the more players will seek to diversify away from it. This is a conundrum highlighted by then US Treasury Secretary Jack Lew in 2017.
Push factors have combined with pull factors to encourage political and economic fracturing, and the result has been increased appetite for the homeshoring and friendshoring of vital goods. Covid-19 vaccines during the pandemic, fuel supplies after the Russian invasion of Ukraine and the crisis in the Middle East have all led to higher prices but more security. This is what Udaibir Das has described as the ‘sovereign premium’.
Although the US’ position in global trade, military heft and diplomatic influence is being chipped away, US leadership is being maintained in finance, helped by the fact that bond market index construction is weighted by market capitalisation. This is a natural support for US assets, especially insofar as FX reserves are concerned.
The hidden power of incumbency
We often read about ‘positive externalities’ when the durability of the dollar’s role in both global finance and in the accumulation of FX reserves is discussed. People are happy to use dollars, because everybody else accepts dollars. However, there is more to this, particularly when it comes to the management of FX reserves.
Iker Zubizarreta at Fondo Latinoamericano de Reservas has described it as the ‘hidden architecture of US dollar supremacy’, and one way in which that manifests itself is through benchmark captivity. This is because the value of FX reserves is expressed in dollars. All currency asset values are converted back into dollars, and this is the number that is presented in the IMF COFER database. The dollar is the numeraire, and this brings power.
Moving into other currencies can lead to difficult questions. Changing a long-standing benchmark to include non-dollar currencies will be time consuming and might also be a governance challenge. Barriers to exit reinforce the importance of the dollar and provide a framework for what qualifies as prudent and what counts as risky. As Zubizarreta describes it, the dollar, as the accounting numeraire, ‘organises perception’. US leadership may be weakening, but the dollar enjoys unique support.
What’s next for FX reserves management?
The GPI survey revealed that gold will continue to benefit as a geopolitical hedge in a world where the dollar slowly recedes and is not replaced by a single fiat currency. The renaissance in gold can be traced to the decision of developed market central banks to cease selling, and the decision of emerging market central banks to start buying. The pivot year was 2008. It was also the year when Russia invaded Georgia, and China began to slowly internationalise the renminbi (the first currency swap line was announced in December 2008, with the Bank of Korea).
The enthusiasm for gold was amplified after the annexation of Crimea in 2014, and again after sanctions (including the freezing of FX reserves) after the full-scale invasion of Ukraine in 2022. The boost to gold as a consequence of geopolitical uncertainty will most likely prove durable. However, it should be highlighted that the growth in gold positions is a combined consequence of both buying and revaluation effects. News headlines do not always distinguish between the two.
Academics have been successful in forecasting the gradual decline of the dollar in FX reserve portfolios, but hopeless at forecasting which currencies will benefit, largely because they are searching for a single winner. The reality is that a wide range of currencies have benefitted, and I would expect this pattern to continue. The euro was undermined by a lack of single issuance entity, then by the prevalence of negative yields, a lack of heft in technology and perhaps recently by a perceived weakness in military power.
The winner will not be a shared Brics currency. As Barry Eichengreen of the University of Berkely argues, the idea of a basket Brics currency is a charade. I agree and argue that the idea of a shared currency is simply impractical for political, economic and mechanical reasons, based on the historical experience of the European exchange rate mechanism.
It is possible that a single member of the enlarged Brics group could grow in importance for settling trade flows between those nations, but the impact will be small. The renminbi may play a growing role, and Herbert Poenisch has argued that a compromise candidate such as the United Arab Emirates dirham could make an impact.
The dollar remains unsinkable
The role of the dollar and that of US Treasuries have in the past been intertwined. It is possible that their futures will be increasingly separate. The dollar is the primary reserve currency, and US Treasury bonds and bills have historically been the default way to express this position. However, with continued US fiscal laxity and provocative ideas about taxing foreign holders of US debt, a wider term premium on long-dated US bonds might heighten the attractiveness of foreign bonds hedged back into dollars. Separation complete.
The good ship dollar may have been holed, but the breach is above the waterline. The vessel may take in water in choppy conditions but in the absence of a more substantial pounding will remain afloat for many years yet.
Gary Smith is Client Portfolio Manager at Columbia Threadneedle.
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