Shifting out of Dollars?
The BIS today issued the March edition of The BIS Quarterly Review. One of the interesting statistics contained in it is the fraction of foreign currency assets owned by international banks that is held in dollars. This fraction seems to have fallen during 2003 and 2004:
March 7 (Bloomberg) — Asian banks, including central banks, reduced the share of their deposits held in dollars in favor of the euro, yen and other currencies in the third quarter of last year, the Bank for International Settlements said. The share of deposits denominated in the U.S. currency fell to 67 percent, from 81 percent in the same period in 2001, the Basel-based BIS said in its quarterly review published today. Total dollar deposits increased, it said.
…Indian and Chinese banks showed the biggest drop. The share of deposits in dollars was reduced to 43 percent of the total from 68 percent in the third quarter of 2001. Chinese lenders cut the share to 68 percent from 83 percent, the BIS said.
I had a couple of immediate reactions to this. First, the obvious question is whether this trend away from dollar assets will continue. Without a doubt, much of it (at least for private sector banks) is because of fears that the dollar is headed for a significant decline in value, particularly against Asian currencies. That probably explains why Indian and Chinese banks showed the biggest drops in dollar asset shares. Once the dollar falls against those Asian currencies, it seems plausible that the diversification away from dollar assets might stop.
My second reaction was to wonder about the following. Suppose that the big fall in the dollar happens, so that the exchange rate risk of holding dollars is perceived to be largely gone. Isn’t it possible that international banks will have become used to holding euro assets instead, and be relatively uninclined to shift back into dollar assets simply because they’re dollars? In other words, I wonder if there might not be some hysteresis inherent to this phenomenon, so that the more that international banks hold non-dollar foreign currency assets, the less interested in holding dollar assets they become.
If so, then the continued propping up of the value of the dollar by Asian central banks (which is what is forestalling the hypothetical future big fall in the dollar) could well have the unintended consequence of hastening the end of the dollar’s dominant status as the world’s reserve currency.