Euro To Replace U.S. Dollar As Reserve Currency By 2020

Includes: ERO
by: Katchum

These days, we need to be wary about the U.S. dollar losing reserve currency status. That's why I started to monitor the Global Foreign Exchange Holdings. These data are provided by the IMF and can be accessed here (pdf).

If we plot a chart over time, it seems that the USD is losing its status as a reserve currency. Although the trend of the USD as a reserve currency is negative, it still accounts for 60% of global foreign exchange holdings around the world. The euro on the other hand is increasingly gaining popularity (See Chart 1). If the trend continues like this, the euro could become the reserve currency by 2020.

(Click charts to expand)

Chart 1: Global Foreign Exchange Holding (allocated reserves)

The total foreign exchange holdings of the latest quarter are given in table 1:

Table 1: Global Foreign Exchange Holdings

The composition of total foreign exchange holdings (Advanced economies vs.Emerging and Developing economies) of the latest quarter is given in table 2:

Table 2: Composition of Global Foreign Exchange Holdings (Advanced economies VS Emerging and developing economies)

When looking at the composition of the global foreign exchange holdings held by advanced economies and emerging/developing economies, we notice that emerging/developing economies are rapidly increasing foreign exchange reserves, while the advanced economies are growing at a slower pace. The reasoning behind this trend is that emerging economies like Brazil, Russia, India and China are building up more and more reserves with their current account surplus as they are growing at a much faster pace. While the advanced economies like the U.S., Japan and Europe are growing at a much lower rate (See Chart 2). Before 2005, advanced economies held more foreign currency reserves than emerging economies. After 2005, it was the opposite.

Chart 2: Global Foreign Currency Reserves held by Advanced Economies VS Emerging Economies

Another point to be made is that the Chinese yuan isn't even incorporated in the statistics of the IMF, because its share in the global foreign exchange holdings in the world is negligible (See chart 3). China does hold a lot of U.S. dollars and U.S. Treasuries (around $US 2 trillion in total), but those are denominated in U.S. dollars and can't be converted into Chinese yuan overnight. If those $US 2 trillion in currency reserves were magically converted into Chinese yuan, then the yuan could start competing against the $US 9.7 trillion of U.S. dollar reserves held by institutions around the world.

Chart 3: Currency share of average daily foreign-exchange turnover


There are three points to be made. First, it's safe to say that the U.S. is still the reserve currency of the world by a big margin, but it is losing favor over time. Second, emerging markets are growing their currency reserves at a much faster pace than the advanced economies due to their competitiveness in trade. Third, the Chinese yuan and the euro still have a long way to go (by year 2020) before they can become the reserve currency of the world.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.