In addition to the fact that Canadian stocks generally offer much higher yields than their US counterparts, US investors have also found the Canadian market attractive because of the country’s economic resilience amid the Global Financial Crisis.

Recognition of that relative strength, along with Canada’s resource riches and conservative financial system, helped boost the Canadian dollar above parity with the US dollar for much of  2011 and 2012.

And while the loonie finally sold off last year, that hasn’t stopped the world’s central banks from continuing to add Canadian dollar-denominated debt to their reserves.

A reserve currency is a currency that is held in significant quantities, usually in the form of highly rated government bonds or bills, by governments and institutions as part of their foreign exchange reserves, which they use to help facilitate international trade.

In this context, a currency can also be accumulated as a precaution for contingencies that require intervention in an exchange rate or restoring liquidity when there’s an extraordinary disruption to the flow of global capital markets. Demand for a particular currency can also help reduce borrowing costs, particularly for governments.

Although the loonie declined 7.4 percent last year, the amount of Canadian dollar-denominated debt reported held among global central banks’ allocated reserves jumped 25 percent year over year, to USD108.5 billion at year-end from USD86.8 billion in the fourth quarter of 2012.

According to the International Monetary Fund (IMF), the Canadian dollar now accounts for 1.7 percent of allocated reserves, up three-tenths of a percentage point from a year ago, ranking it fifth among the world’s currencies.

By this measure, the US dollar still dwarfs other developed-world currencies, accounting for 61.2 percent of central banks’ allocated reserves. The euro comes in a distant second at 24.4 percent, the British pound is at 4 percent, and the Japanese yen is at 3.9 percent.

However, concern about American profligacy is causing foreign central banks to slowly diversify away from the US dollar. The IMF reports that the US dollar’s share of the currency composition of official foreign exchange reserves (COFER) has slid nearly 10 percentage points since 1999.

And that trend partially explains the Canadian dollar’s recent ascendance to the top ranks of global reserve currencies, an exclusive club that traditionally has been dominated by the US dollar, the euro, the Japanese yen, the British pound and the Swiss franc.

As subscribers to our sister publication Australian Edge already know, the Australian dollar has enjoyed a similar rise to prominence over the past half decade, and now ranks just behind the Canadian dollar among reserve currencies, though both are essentially neck and neck in terms of the value of reported holdings.

Based on conversations with reserves managers around the world, the Bank of Canada (BoC) attributes the newfound reserve status of the loonie and the aussie to not just central banks’ desire to diversify away from the greenback, but also the perceived safety of the two countries and the opportunity to earn higher yields than found in traditional reserve currencies.

And this demand might be even greater than the COFER data suggest. Since not all of the foreign reserves managers responded to the IMF’s request for data, the BoC estimates that the actual amount of Canadian dollar-denominated debt among the world’s reserve holdings is nearly double the official figure, at roughly USD208 billion.

The BoC arrived at this figure by extrapolating the percentage held among allocated reserves, which are roughly 53.3 percent of the USD11.7 trillion in total global reserves, to unallocated reserves, which comprise the balance of global reserves.

The term “unallocated reserves” simply refers to those countries that reported their total foreign exchange reserves, but failed to disclose the actual composition of those reserves. The central bank also notes that before arriving at this estimate, it used a variety of approaches that resulted in a range from USD172 billion to USD219 billion.

Furthermore, central banks’ demand for the Canadian dollar is likely to be relatively stable over time. In contrast to currency traders who flit in and out of positions, the BoC observes that foreign reserves managers are characterized as patient, buy-and-hold investors whose primary objectives are preserving capital and maintaining liquidity, while maximizing returns within those constraints.

Interestingly, while countries that have substantial two-way trade tend to hold higher proportions of their respective currencies, the emerging markets, with which Canada has yet to establish strong trade ties, accounted for about two-thirds of foreign holdings of Canadian dollar-denominated debt. And demand from these fast-growing economies means the loonie’s share of foreign holdings will likely continue rising.

The BoC believes developing countries are starting to favor the loonie because the higher yields of Canadian securities offset some of the higher expenses their central banks incur when holding these assets.

Or perhaps they also recognize that in turbulent times Canada will likely remain a relative safe haven compared to its developed-world peers. After all, a country’s foreign reserves don’t exist solely to serve international trade, they’re also an insurance policy.