Gary Smith
Head of EMEA Client Portfolio Manager team, Fixed Income
Reserves are growing, but so is the reluctance to use them.
The most striking result from OMFIF’s 2026 Global Public Investor (GPI) survey is that no central bank surveyed anticipates reducing its foreign exchange reserves, reinforcing the enduring role of both foreign exchange and gold reserves as strategic stores of value. The implications of this trend were explored in an OMFIF white paper co-authored with economic advisor John Nugee in 2016.
This appetite for more reserve accumulation persists even though many nations already hold reserves in excess of traditional International Monetary Fund adequacy measures. While the experience of past crises helps to explain this preference, it also raises an important question: how can central banks best balance the benefits of large reserve holdings against the challenges they create?
The GPI survey also revealed a notable paradox: while central banks continue to accumulate reserves, they remain reluctant to use them. In the event of a crisis, more than half of respondents indicated they would be unwilling to deploy more than 10% of their reserves during a crisis. This asymmetry has its roots in the UK’s sterling crisis of 1992 and intensified after the Asian financial crisis of the late 1990s. Over time, reserve accumulation has become an objective, firmly embedded in central bank behaviour.
The role of the dollar in FX reserves
FX reserves are a national safety net. They are the water trough from which every horse expects to drink in a crisis. The range of contingencies reserves may be called upon to support continues to expand – a trend reinforced by the fallout from the 2008 global financial crisis and the Covid-19 pandemic.
Because the nature of the next crisis is unknowable, the size of the required safety net cannot be defined. Faced with a growing number of potential demands on reserve assets, central banks are reluctant to commit excessive resources to addressing the first crisis, aware that another may be just around the corner.
The OMFIF survey revealed that the US dollar was the only currency to which FX reserve managers, as a group, planned to reduce their exposure. This is hardly surprising. According to the IMF’s Currency Composition of Official Foreign Exchange Reserves (COFER) data, the dollar’s share of reported global reserves has gradually declined over the past quarter century, falling from roughly 70% to 57% today. Looking ahead, reserve managers expect this trend to continue: on average, respondents projected that the dollar’s share will fall to 50% over the next decade. That expectation appears reasonable, reflecting the continued diversification of reserve portfolios rather than any imminent challenge to the dollar’s dominant role in the international financial system.
Even if the dollar’s share of FX reserves falls to 50%, it would remain the dominant reserve currency by a considerable margin. Such a weighting would still far exceed that of the euro, at roughly 20%, and the renminbi, at around 2%. Any discussion of the dollar’s role in reserve portfolios must therefore begin with a simple reality: the US currency remains the centre of gravity for the international monetary system.
What is behind the dollar’s gradual decline?
The weaponisation of the dollar, which accelerated in the aftermath of the 2001 terror attacks, has contributed to the gradual decline in the dollar’s share of global FX reserves. While the Patriot Act was designed to combat terrorist financing, it has increasingly become a tool for advancing US national security objectives through the international financial system.
This creates a dilemma. The US enjoys the enviable position of being able to leverage its financial system in pursuit of foreign policy goals, but the more frequently it does so, the stronger the incentive for other countries to diversify their reserve holdings. This tension was highlighted by former US Treasury Secretary Jack Lew in 2017, who warned that the extensive use of financial sanctions could, over time, encourage efforts to reduce dependence on the dollar.
Push and pull factors have combined to accelerate political and economic fragmentation, increasing the appeal of reshoring and friendshoring critical supply chains. The scramble for Covid-19 vaccines, the search for alternative energy supplies following Russia’s invasion of Ukraine, and disruptions arising from conflict in the Middle East have all reinforced a common lesson: greater security often comes at a higher cost. This is what Udaibir Das has termed the ‘sovereign premium.’
While the US’s share of global trade, military influence and diplomatic influence may be gradually declining, its dominance in global finance remains largely intact. This position is reinforced by the market-capitalisation-weighted construction of major bond indices, which naturally favours US assets. As a result, structural support for dollar-denominated assets – and by extension the dollar’s central role in global FX reserves – remains firmly in place.
The hidden power of incumbency
Discussions about the durability of the dollar’s role in global finance and FX reserves often focus on network effects. Countries and institutions use dollars because other countries and institutions use dollars. Yet the dollar’s resilience rests on more than these positive externalities, particularly in the management of FX reserves.
Iker Zubizarreta of Fondo Latinoamericano de Reservas describes this phenomenon as the ‘hidden architecture of US dollar supremacy.’ One manifestation is what might be termed benchmark captivity. Because FX reserves are measured in dollars, the value of all reserve assets is ultimately translated back into dollars before being reported in the IMF’s COFER database. The dollar serves as the numeraire, and that status brings significant influence.
Diversifying into non-dollar currencies can therefore raise practical challenges. Revising long-established benchmarks is time-consuming and may require complex governance approvals. These barriers to exit reinforce the dollar’s central role while shaping perceptions of what constitutes prudent portfolio management and what is considered risky. As Zubizarreta argues, the dollar, as the accounting numeraire, ‘organises perception.’ US leadership may be evolving, but the dollar continues to benefit from deeply embedded structural advantages.
What’s next for FX reserves management?
The GPI survey suggests that gold will continue to benefit as a geopolitical hedge in a world where the dollar’s share of reserve assets gradually declines without being supplanted by a single alternative fiat currency.
The modern renaissance in gold can be traced to two developments: developed-market central banks largely stopped selling gold, while emerging-market central banks began accumulating it. The turning point was 2008 – a year that not only coincided with the global financial crisis, but also with Russia’s invasion of Georgia and the early stages of the renminbi’s internationalisation marked by the announcement of China’s first currency swap line with the Bank of Korea.
Central-bank enthusiasm for gold intensified following Russia’s annexation of Crimea in 2014 and accelerated further after the sweeping sanctions imposed following the full-scale invasion of Ukraine in 2022, including the freezing of Russian FX reserves. The case for gold as a hedge against geopolitical uncertainty is therefore likely to remain durable. However, it is important to recognise that growth in official gold holdings reflects not only net purchases but also valuation effects arising from rising gold prices. News headlines do not always distinguish between the two.
Academics have been relatively successful in forecasting the gradual decline of the dollar’s share of FX reserves, but far less successful in identifying which currencies would benefit. The primary reason is that many analyses assume there must be a single successor to the dollar. Diversification has been spread across a range of currencies, and this pattern is likely to continue. The euro’s ability to gain market share has been constrained by factors including the absence of a single sovereign issuer, a prolonged period of negative interest rates, a limited presence in the technology sector and, more recently, perceptions of weakness in military power.
The dollar’s gradual decline is unlikely to pave the way for a shared Brazil, Russia, India, China, and South Africa (BRICS) currency. As Barry Eichengreen of the University of California, Berkely has argued, the concept of a basket-based BRICS currency is largely illusory. Historical experience, including the challenges encountered under the European Exchange Rate Mechanism, suggests that a shared currency would face formidable political, economic and operational obstacles.
It is possible that individual members of an enlarged BRICS bloc will play a greater role in facilitating trade settlement among participating countries, but the overall impact on the international monetary system is likely to be limited. The renminbi may continue to gain ground, while Herbert Poenisch has argued that a compromise candidate such as the United Arab Emirates dirham could assume a larger role. Even so, the future is more likely to be characterised by gradual diversification across multiple currencies than by the emergence of a single challenger to the US dollar.
The bottom line
Historically, the role of the dollar and US Treasuries has been closely intertwined. Going forward, however, their fortunes may become increasingly distinct. The dollar remains the world’s primary reserve currency, and US Treasury bonds and bills have traditionally been the default vehicle through which reserve managers express that preference. Yet persistent US fiscal deficits and periodic proposals that would disadvantage foreign holders of US debt could push term premiums higher, increasing the appeal of non-US sovereign bonds hedged back into dollars. In other words, confidence in the dollar need not by synonymous with confidence in Treasuries.
The good ship dollar may have sprung a leak, but the breach remains above the waterline. The vessel may take on water in choppy seas, yet absent a much more severe shock, it is likely to remain buoyant for many years to come.
