Citi FX strategist Steven Englander has been talking a lot about the huge massive supply of dollars held by foreign central currency reserve managers, and the tricky situation of dumping them, despite the overriding belief that they’re currently being “debased.”In a note today, he lays out the conditions — or what he calls the “litmus test” — by which the USD would lose its reserve currency status.
Just about every day we read about some new plan to dethrone the USD as the world’s chief reserve currency — whether it is investing reserves in SDRs, or denominating more trade in currencies other than USD, or replacing the USD in reserve portfolio’s with EM currencies, or adopting a new gold standard or handing a chunk of reserves to outside managers or sovereign wealth funds, or buying commodities or commodity currencies, etc. Many of these are fine ideas and some might even have merit.
The problem is that none of these are workable without the USD falling a ton. And if reserve managers were willing to accept the USD drop, they probably would not have accumulated the last USD2-3trn of reserves.
Consider the reason that reserves have accumulated in the first place. There is a large global overhang of USD, except in periods of acute risk aversion. The US current account deficit and the low attractiveness of US assets mean this overhang is growing. EM reserve managers step in to fill in the gap between the excess global supply of dollars and the limited private demand. They do so reluctantly and for macro economic stabilisation purposes, not because they feel that they need more USD in their portfolios.
It seems to me that the reason we churn through so many proposals for reducing the dollar share in reserve portfolios is that this adding up condition is ignored. There are plenty of candidate assets to replace the dollar in reserve portfolios — what is missing is a plan to create demand for the unwanted dollars elsewhere.
I have strong doubts as to whether there is a workable plan that replaces the dollar in reserve portfolios that does not involve significant dollar weakness. But if there is a workable version of such a plan, my guess is that it will be adopted quickly and universally.
So, when the conditions are in place such that a collapse in the dollar won’t hurt all these countries, then the USD’s special status is toast.
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