Fiscal Policy | FX | Politics & Geopolitics | US
Refounded US Multilateralism Unlikely to Restore Dollar Fortunes
- By Dominique Dwor-Frecaut
- 3 min read
There is a strong relationship between countries’ dollar share of foreign reserves and their dependency on the US for their security, according to the ‘Mars hypothesis’. For instance, Japan, Korea, Taiwan, Saudi Arabia and Germany, which rely on the US for their security, have a much greater dollar share in their foreign exchange reserves than China, Russia, France and the UK, which are either strategic rivals of the US or possess nuclear deterrents. In addition, a study of 19 countries pre-WWI shows a clear influence of military alliances on their foreign reserves currency composition.
In recent years, the dollar share of global foreign reserves has generally followed the Mars model’s predictions. It declined under the Trump administration’s policy of global disengagement and unilateralism (Chart 1). But the decline partly reflects the gradual inclusion of Chinese FX reserves in the IMF statistics on the Currency Composition of Official Foreign Exchange Reserves (COFER). The inclusion, which started in 2015, saw the share of global reserves included in the IMF statistics rise and the share of the dollar fall, even if the latter is adjusted for exchange rate changes. This likely reflects that China holds a lower dollar reserves share than its global peers. By 2018, the inclusion of Chinese reserves in the IMF statistics was completed, and the share of global reserves reported to the IMF stabilized. Yet, even adjusted for exchange rate changes, the share of the dollar continued to slide.
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