World's Currency Reserves Start Shrinking

What Smaller Reserves Mean for Global and U.S. Economies

World's Currency Reserves Start Shrinking
May 6, 2015

Over the past decade, the amount of foreign currency reserves held by global central banks has increased at an astonishing rate: by an average of $824 billion a year. As a result, global foreign currency reserves topped $12 trillion last August for the first time, a new record.

However, this decade-long trend has now come to a sudden and screeching halt. In March, global foreign currency reserves fell to $11.6 trillion. In addition, foreign currency reserves in emerging markets (where about two-thirds of reserves are held) fell in 2014 by $114.5 billion to $7.74 trillion, according to the International Monetary Fund (IMF). This was the first annual decline in foreign currency reserves in emerging and developing economies since 1995.

Impact of the Strong Dollar

There is no question that one factor in the fall in global foreign currency reserves is the strong U.S. dollar against most foreign currencies — especially the euro, which fell to a twelve-year low against the dollar in March. In addition, emerging market currencies have fallen fifteen percent against the dollar in the past year alone. In a poll conducted by the Financial Times, nine out of ten emerging market economists said emerging markets have passed a period of peak reserves and could continue to lose foreign currency reserves in the months to come.

The strong U.S. dollar aside, falling global foreign currency reserves are very real — and this could have a profound impact on global markets, especially emerging markets. These falling reserves could make it more difficult for emerging market countries to increase their own money supplies and thus strengthen economic growth without additional stimulus.

Foreign currency reserves held by emerging market nations exploded over the past decade, soaring from $1.7 trillion in 2004 to nearly $8 trillion in early 2014. This was a factor in the growth of the global economy during this time, as emerging market nations invested capital in U.S. and European debt markets, helping fuel their growth.

If this dynamic starts reversing itself, it could affect economic growth in developed nations, including the U.S. This is especially true given that the Federal Reserve is widely expected to tighten monetary policy by raising interest rates sometime this year.

Impact on the Euro

Shrinking global foreign currency reserves could also accelerate declines in the euro, which has fallen against 29 of 31 major currencies so far this year. Last year, the euro’s share of global reserves fell to its lowest level since 2002 — just 22 percent. Meanwhile, the U.S. dollar accounted for 63 percent of global reserves last year — the highest level in five years, according to the IMF.

China is the world’s largest holder of foreign currency reserves, and its actions have contributed heavily to the shrinking reserves. China sold about $200 billion in reserves during the second half of last year in an effort to strengthen its own currency. In addition, Russia’s reserves have fallen by 25 percent over the past year to just $361 billion.

Foreign currency reserves may not be the most publicized or recognized economic indicator, but they can have a major impact on the global and U.S. economies. This makes them worth keeping a close eye on throughout the rest of the year.

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