The International Monetary Fund’s recently released Currency Composition of Official Foreign Exchange Reserves (COFER) report suggests global finance could be at the cusp of a paradigm shift away from the U.S. dollar. With the rise of rival currencies such as the euro and China’s yuan poised to go digital, the USD’s dominance could dim even more in the years to come, analysts say.

Central bank digital currencies (CBDCs) must compete with two obstacles to successfully challenge the USD, however: rivalry from private cryptocurrencies as stores of value against inflation, and regulatory uncertainty regarding implementation.

New lows for the dollar

In Q4 of 2020, global reserves of the U.S. dollar sunk to a 25-year record low of 59%, according to the IMF report. USD last dipped below 60% in 1995.

“Some analysts say this partly reflects the declining role of the US dollar in the global economy, in the face of competition from other currencies used by central banks for international transactions,” the IMF explained in a blog post. “If the shifts in central bank reserves are large enough, they can affect currency and bond markets.”

Though the U.S. dollar remains the world’s dominant reserve currency, the downward trend has many wondering what brought it about and whether its position would continue to erode.

Some cite a combination of nations shifting away from USD and the rising status of competing currencies like the euro, the Japanese yen and the Chinese yuan as factors in the USD’s slump. But others say that even with China’s advances in developing a digital yuan, the U.S. dollar’s hegemony does not face any real rivalry — for the time being. 

A changing financial landscape

“For the digital yuan to emerge as a serious contender to the USD or even the Euro, there would have to be a policy shift by Chinese regulatory authorities to allow the RMB to freely float on global currency exchange markets. And no one sees that happening in the near future,” Andrew Work, co-founder and director of the Lion Rock Institute in Hong Kong, told Forkast.News in an email. 

But it might be a different story within Asia and among countries that count China as a key trading partner. 

“The ability to see, track and retract the digital yuan may give [China’s central bank] more confidence to allow a little more to flow into neighbouring client economies like Cambodia and Laos and displace the use of the USD there. The Philippines may also be a target for the displacement of the local currency and USD,” Work said. “While other jurisdictions may restrict the use of the digital yuan, these countries would find it hard to say no, even at the risk of seeing their own currency become a second-tier player in their own borders.”

Though the digital currencies likely won’t tarnish the dollar’s luster on global markets anytime soon, analysts say, the IMF report may indicate a slow move away from USD as major players begin to choose alternative assets for their reserve baskets.  

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Source: IMF


Compared to other reserve currencies, US dollar dominance continued decline in 2020.

Countries seek to exit dollar dominance, enter euro and Chinese yuan

Russia and China have both stepped away from an uncertain and politically entangled U.S. dollar in recent years, with the Central Bank of Russia (CBR) ditching over US$101 billion in dollar-denominated reserves in early 2019, and publishing data early this year revealing it held more gold than USD in reserves as of June 2020. Some have cited U.S. sanctions against the nation after its annexation of Crimea as the reason for jettisoning the dollar.

By September 2021 dollar-denominated assets were at about 20% of the total Russian holdings. This is down from 50% in 2017.

China has for its part has loosened grip on U.S. government securities, with a reported 20% decrease in these holdings over roughly seven years, according to U.S. Treasury Department data. SMBC Nikko Securities senior economist Kota Hirayama told Nikkei Asia of Japan: “Most of China’s Treasury holdings are part of its foreign reserves.”

While Russia’s holding of gold over dollars may not be typical to central banks across the world, the IMF report shows the currencies popular as reserve assets with the Central Bank of Russia  — like the yuan and euro — are growing in favor globally. 

A move toward digital dominance?

According to the IMF report, both the euro and Chinese yuan saw their small piece of the US$12.7 trillion foreign exchange reserve pie grow. The euro’s share increased 21% from Q1 2016 to Q4 2020, and the yuan surpassed 2% of global reserves by the end of 2020. 

Other currencies like the Japanese yen — which topped 6% of global reserves for the first time in 20 years — are also on the rise. What’s unique about the yuan, though, and to a lesser degree the euro, is that they are moving toward becoming digital currencies — which could make them a lot easier to use in the future compared to a U.S. dollar-based system in trade and other cross-border transactions.

See related article: 5 US digital dollar pilots launching to chase China’s CBDC lead

One example of this is the April 28 European Investment Bank (EIB) issuance of blockchain-based CBDC digital bonds. Done in partnership with Banque de France, the issuance was called “an experiment on the use of Central Bank Digital Currency (CBDC) for settling digital bonds issued by the EIB on a blockchain.”

The total value of the bonds was 100 million euros (about US$121.6 million). Also involved in the Ethereum-based project were Societe Generale, Santander and Goldman Sachs.

For the yuan’s part, China has been the trailblazer among major countries when it comes to development of a central bank digital currency. Already seven years in the making, China’s digital yuan — officially known as e-CNY but still colloquially called by its earlier name, DCEP (“Digital Currency, Electronic Payments”) — has not yet launched. But the People’s Bank of China has already established a working prototype, run multiple pilots, and has been testing out the digital yuan over the past year with banks, retailers and millions of citizen-users. 

Digital currencies in competition — for the people, the banks, or both?

“These ‘govcoins’ are a new incarnation of money. They promise to make finance work better but also to shift power from individuals to the state,” notes The Economist in a recent article on “the rise of e-money.”

As some private sector cryptocurrencies such as Bitcoin are capped, non-inflationary and decentralized in distribution and development, they could be in competition with digital fiat as stores of value.

“Many investors think all this monetary and fiscal stimulus will debase fiat currencies, so cryptocurrencies — especially coins like Bitcoin that have limited supply — are attractive as inflation hedges,” Frances Coppola, author of “The Case for People’s Quantitative Easing,” told Bloomberg last year. “Bitcoin’s strength relies very much on fiat money being copious and unrewarding.” 

European Central Bank president Christine Lagarde summed up the growing apprehension of regulators in March, saying, “Central banks need to keep with the rapid pace of innovation, if they are to ensure that money remains sound, payments efficient, and the financial system stable.”

The Economist article notes central banks fear losing control of a private asset that has become increasingly important in financial markets. “Bitcoin has gone from being an obsession of anarchists to a $1trn asset class that many fund managers insist belongs in any balanced portfolio.”

CBDC development continues, but the U.S. has cold feet

Controversy about the benefits and drawbacks of CBDCs notwithstanding, governments around the world are nonetheless increasingly exploring, researching or testing the implementation of digital, programmable fiat. All eight central banks of the top currencies from the IMF report are either considering, researching or actively developing a CBDC.

In the U.S., however, despite private sector advocacy and research into a digital dollar, a government-backed digital currency still seems a long way off.

U.S. government officials have repeatedly expressed coolness toward the idea of a digital dollar and not wanting to rush into recreating the existing American monetary system. 

As Federal Reserve chairman Jerome Powell noted in March: “We have a two-tier system: central banks interface with banks, banks interface with the public. And we do not want to destabilize that.”

According to Work of the Lion Rock Institute, it’s not clear that a U.S. CBDC would pay many dividends — at least when it comes to public opinion.

“It’s hard for the general public to see the difference between a CBDC (like the digital yuan) and a well-functioning digital payment processing system, so there is no reason they might prefer an M0 level US Federal Reserve CBDC versus current options.”

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Powell also suggests that the CBDC that will likely launch in China might not go over well in democratic U.S., whose citizenry values privacy.

“The currency that’s being used in China [digital yuan] is not one that would work here, Powell said, at a press conference last month. “It’s one that really allows the government to see every payment that’s used for which it is used in real time.”

Powell has repeatedly noted there’s no need for the U.S. to rush on a CBDC, citing the USD’s status as the world’s reserve currency.

But if the trends noted by the IMF hold, the U.S. Federal Reserve may not have as much time as it thinks to remain competitive in a rapidly evolving financial landscape. 

“America should watch China for now and not lose any sleep,” said Work, of the Lion Rock Institute. “Cambodia and Laos should be preparing for the end of the riel and the kip if they don’t have plans to actively resist such a fate.”