Peter Zoellner, the Head of the Banking Department at the Bank for International Settlements (BIS), shared his insights at the ACI Financial Markets Association congress in Berlin over the weekend. He announced that the dollar’s proportion of central bank reserves might decrease by 10 to 15 percent in the years to come.
But Dr. Zoellner reassures us there’s no need for alarm. He believes that even with the diminishing role of the dollar in foreign exchange reserves, its status as the world’s reserve currency will remain unthreatened. This insight is indeed noteworthy.
“The percentage could decline from between 65 to 70 percent down to around 50 to 60 percent,” Dr. Zoellner stated. “However, I do not anticipate that the dollar’s relative dominance will change in the next 10 or 20 years.”
But how can Dr. Zoellner predict the next couple of decades? In reality, he doesn’t hold a crystal ball; he seems to be forecasting future trends based on past data, much like predicting tomorrow’s weather by referencing yesterday’s sunshine.
What we gather is that Dr. Zoellner has studied bar graphs and pie charts depicting the evolution of foreign exchange reserves over time, using this data to inform his predictions.
Thumbtack Analysis
According to the IMF, “the share of U.S. dollar holdings in global foreign exchange reserves peaked at 71.5 percent at the end of 2001, which coincided with the dollar’s peak valuation in March 2002. Following that, it steadily declined to 61.8 percent by 2010, driven by a decrease in the value of U.S. dollar holdings.”
Since 2010, though, the dollar’s share in foreign exchange reserves has oscillated between 61 and 62 percent. Could this be the floor for dollar holdings by central banks? Dr. Zoellner doesn’t think so.
To illustrate his viewpoint, he metaphorically placed a thumbtack at 71.5 percent for 2001 and another at 62 percent today, projecting a further decline to his 50 percent estimate for the coming decade or two. Furthermore, he seems to suggest that just because the dollar has already dropped by 10 percentage points and still retains its status as a reserve currency, it could similarly withstand another decline of the same magnitude.
Dr. Zoellner could be correct, or he may not be. Only time will reveal the outcome, as numerous factors contribute to this equation.
For instance, consider the balance of trade and fracking. A few weeks ago, we highlighted the paradox that Japan currently faces. Their attempts to devalue the yen and stimulate exports are being significantly counterbalanced by the rising costs of energy imports. Unfortunately for Japan, a country reliant on energy imports, a weaker yen inflates the cost of these imports.
Forecasting for Dummies
Conversely, the U.S. balance of trade, which has been largely negative for over 40 years, is showing signs of improvement. With advancements in fracking, the U.S. is set to become the world’s leading oil producer in 2015. Will this development be a fleeting boost or signal a new energy revolution?
Again, only time will tell. However, the current trend shows that exports are helping reduce the U.S. trade imbalance. So, what’s the takeaway?
The lesson here is that past trends aren’t always reliable indicators of future outcomes. The recent U.S. energy boom could not have been predicted based on historical data, which painted a bleak picture of U.S. oil production peaking in 1970 and then slowly waning over the next four decades. How could this trend possibly change?
Factors such as human innovation, technological breakthroughs, and new reserves are not easily forecasted by analyzing historical data. These developments, like the shifting composition of foreign central bank reserves and the dollar’s ongoing status, cannot simply be predicted by marking points on a graph. A sustained U.S. energy surge could temporarily enhance the dollar’s standing globally.
What Dr. Zoellner’s approach seems to overlook is that shifts in global reserve currencies are not easily foreshadowed. Such changes occur only once every century or two. Thus, while the dollar might gradually fade from prominence among foreign central banks, the timeline is uncertain—it could be a decade or even half a century.
Nevertheless, the inflection point will likely be obscured until it manifests. In essence, the dollar’s descent may unfold gradually, only to culminate suddenly.
The insiders at the BIS may find themselves caught off guard.
Sincerely,
MN Gordon
for Economic Prism
