Peter Zoellner is Head of the Banking Department at the Bank for International Settlement (BIS). He holds a PhD from Vienna University of Economics and Business Administration. Over the weekend, he told the ACI Financial Markets Association congress in Berlin that the dollar’s share of central bank reserves may fall by 10 to 15 percent in the years’ ahead.
Yet not to worry about a thing, assures Dr. Zoellner. The reduced use of the dollar by central banks as foreign exchange reserves won’t threaten its world reserve currency status. This is a remarkable insight, indeed.
“It could happen that the percentage will go slightly down with the reserve currency from between 65 and 70 maybe to between 50 and 60 percent,” said Dr. Zoellner. “But the relative dominance of the United States dollar I do not believe that this will change for the next 10, 20 years.”
So how does Dr. Zoellner know what will happen over the next 10 or 20 years? In short, he doesn’t. We suppose he’s merely predicting tomorrow’s weather based on how sunny it was yesterday.
What we mean is, we presume Dr. Zoellner’s squinted his eyes while looking at bar graphs and pie charts of foreign exchange reserves…and has observed how that composition changes over time. He then just extrapolates out the past into the future.
Thumbtack Analysis
According to the IMF, “the share of U.S. dollar holdings in global foreign exchange reserves peaked at 71.5 percent at end 2001, coinciding with the dollar’s peak valuation in March 2002. Subsequently it declined steadily to 61.8 percent in 2010, driven by the decline in the value of the U.S. dollar holdings.”
Since 2010, however, the dollar’s percent allocation by foreign exchange reserves has bounced around at about 61 to 62 percent. Could this be a bottom for the percent holdings of dollars by central banks? Not by Dr. Zoellner’s estimation.
As far as we can tell, he placed a thumbtack at 71.5 percent in 2001 and another at 62 percent today, and then projected out 10 or 20 years to come up with his 50 percent target. Similarly, Dr. Zoellner assumes that because the dollar’s dropped 10 percentage points and still remains the reserve currency…the same would be true if it dropped another 10 percentage points.
Dr. Zoellner may be right. He also may be wrong. The answer will be revealed in due time. Certainly, there are a lot of factors involved.
Namely, there’s the balance of trade…and fracking. Several weeks ago we alerted you to the fantastic paradox Japan finds itself in. Their efforts to cheapen the yen and boost exports are being more than offset by the rising price of energy they must import. Unfortunately for Japan, a country that imports most of its energy, a weaker yen makes energy imports more expensive.
Forecasting for Dummies
Conversely, the U.S. balance of trade, which has generally been negative for over 40-years, has been narrowing. Thanks to advancements in fracking, the U.S. will be the world’s top oil producer in 2015. Will this turn out to be a short term boost or a total energy renaissance?
Again, time will tell. But for now exports are driving the U.S. trade imbalance down. What’s the point?
The point is, a look to the past could never have predicted the new U.S. energy boom. In fact, a look to the past shows a grim picture of U.S. oil production peaking in 1970 and slowly declining over the next 40-years. How could this trend line change?
Human ingenuity, new technological advancements, new discoveries, and increasing reserves are things that can’t be predicted by looking at the past. They are the interaction of decades of trial and error seemingly appearing from nowhere. Like the dollar’s composition of foreign central bank holdings, or maintenance of its dollar reserve status, these are the sorts of things that can’t be predicted by placing thumbtacks on charts. Moreover, a sustained U.S. energy boom may temporarily buoy up the dollar’s status around the globe.
What Dr. Zoellner’s forecasting for dummies method seems to be missing is that a change to the world reserve currency is difficult to foresee. For it only happens once every century or two. Along these lines, the dollar could continue to slowly fall out of favor with foreign central banks. It may take a decade or it may take half-a-century.
But the inflection point will not be readily apparent until the moment it happens. In other words, the dollar’s slide will be gradual…then all at once.
The dummies at the BIS won’t know what hit them.
Sincerely,
MN Gordon
for Economic Prism
