Latest / The Emerging Markets Podcast with Fexingo: Developing Economies, Growth, and Investment / How Emerging Market Currencies Are Building a New Reserve System
Transcript
- Lucas: So Luna, you see that number on the screen? The trade-weighted dollar index has slipped to 118.9, down just a touch from last week. It feels like a nothing move, but I think it's part of a bigger story that's been building for a while. Luna: You mean the quiet de-dollarization story that every economist loves to argue about? I'm guessing you're not just talking about a one-week blip. Lucas: Exactly. Look, for years we've heard that the dollar's dominance is permanent. But if you actually dig into what central banks in emerging markets are doing, there's a structural shift happening. And it's not driven by some political slogan — it's driven by math and risk management. Luna: Before you go deep, you know what keeps these conversations going? A couple of dollars a month from listeners. If you've gotten something out of the show, buy me a coffee dot com slash fexingo. It genuinely makes a difference. Lucas: Yeah, it really does. We don't run ads, so that's how we keep the lights on. Anyway, back to the dollar. The key data point that I want to zoom in on — it's not just the index level, it's what central banks are actually holding. Lucas: According to the IMF's latest survey, emerging markets now hold about 30 percent of their reserves in non-dollar assets, up from roughly 25 percent a decade ago. That's a huge shift when you think about the scale of those reserves — we're talking trillions of dollars. Luna: Thirty percent — that's not a rounding error. What's driving it? Is it geopolitics, or is it just basic portfolio theory? Lucas: It's a mix, honestly. On the one hand, you have countries like Russia that were forced to diversify after sanctions froze a chunk of their dollar assets. On the other, you have India and China who are just trying to reduce their exposure to a currency they don't control. Luna: So it's part defensive, part offensive. And gold has been a big part of that, right? I saw that central bank gold buying hit another record last year. Lucas: Yeah, gold is the standout. The World Gold Council says emerging market central banks bought over 800 tons last year, and they've been on a buying spree for over a decade. It's not just the usual suspects either — Brazil, India, even Kazakhstan have been adding. Luna: But isn't that just a hedge against inflation? Or is it more about signaling? Lucas: It's both, but there's a deeper angle. When you look at the composition of reserves, the shift isn't just into gold — it's also into other currencies, especially the Chinese yuan. The yuan's share of global reserves has doubled from about 1.5 percent in 2016 to over 3 percent now. Luna: Three percent still sounds small. But I guess when you're talking about global reserves, every percentage point is worth a lot of money. Lucas: Right, and it's growing from a low base. China has been pushing hard to internationalize the yuan, especially through bilateral swap agreements. I was looking at the numbers — they've got swap lines with over 40 countries now, totaling something like 4 trillion yuan. Luna: That's a lot of firepower. So how does that actually play out in trade? I mean, are companies in emerging markets actually using yuan for transactions, or is it just central bank window dressing? Lucas: It's becoming real. Take Russia — after the sanctions, they shifted a big chunk of their oil and gas trade to yuan-denominated contracts. China is Russia's biggest energy buyer, so that's billions of dollars worth of transactions flowing through yuan instead of dollars. Luna: And that's not just a Russia-China thing, right? I've read about India paying for Russian oil in rupees, and Brazil talking about yuan settlement with China. Lucas: Exactly. India and Russia have been working on a rupee-rouble mechanism, and Brazil's central bank has been vocal about wanting to settle more trade in local currencies. It's a slow process, but the direction is clear. Luna: So what does this mean for investors? If the dollar loses its safe-haven status, shouldn't that be bad for US assets? Lucas: It's not that simple. The dollar is still the dominant reserve currency by a mile — about 58 percent of global reserves are still in dollars. But the trend is downward. And that has implications for emerging market currencies and equities. Luna: Give me a concrete example. Lucas: Well, look at the ETF flows. EEM, the broad emerging markets ETF, is down half a percent over the last five days, but it's actually holding up better than I'd expect given the dollar's strength. And then you have specific country funds like EWZ, Brazil, which is up over 3 percent in the same period. Luna: So Brazil's currency strengthening against the dollar is helping their stock market? That's a nice tailwind. Lucas: Exactly. The real is up against the dollar this year, partly because of high interest rates and partly because of commodity prices. But as more trade settles in local currencies, that could reduce the pass-through of dollar moves into EM asset prices. Luna: That would be a big deal. I mean, for years, the rule was 'when the dollar sneezes, emerging markets catch a cold.' If that link is weakening, it changes the whole investment thesis. Lucas: It does. And there's a specific mechanism to watch: the dollar index. I noted it's at 118.9, down from 119.18 a week ago. It's a small move, but if that trend continues, it could take pressure off EM central banks to defend their currencies. Luna: And that could mean lower inflation and more room for rate cuts, which would be a boost for EM equities. Lucas: Exactly. But let's not get ahead of ourselves. The dollar is still king. And there are a lot of structural reasons why it's going to stay that way — deep bond markets, rule of law, network effects. Luna: So this isn't about the dollar collapsing, it's about the system becoming more multipolar. Lucas: That's the right way to frame it. We're not heading to a world where the dollar disappears, but we are heading to a world where emerging markets have more options. And that's a gradual, but significant, shift. Luna: I think that's a great note to end on. Thanks for breaking that down, Lucas. Lucas: Always a pleasure. And to our listeners, if you want to keep these conversations going, remember the coffee link. Until next time.