Foreign exchange reserves (also called forex reserves or FX reserves) are
cash
In economics, cash is money in the physical form of currency, such as banknotes and coins.
In bookkeeping and financial accounting, cash is current assets comprising currency or currency equivalents that can be accessed immediately or near-immed ...
and other reserve assets such as
gold
Gold is a chemical element with the symbol Au (from la, aurum) and atomic number 79. This makes it one of the higher atomic number elements that occur naturally. It is a bright, slightly orange-yellow, dense, soft, malleable, and ductile ...
held by a
central bank
A central bank, reserve bank, or monetary authority is an institution that manages the currency and monetary policy of a country or monetary union,
and oversees their commercial banking system. In contrast to a commercial bank, a centra ...
or other
monetary authority
In finance and economics, a monetary authority is the entity that manages a country’s currency and money supply, often with the objective of controlling inflation, interest rates, real GDP or unemployment rate. With its monetary tools, a mon ...
that are primarily available to
balance payments of the country, influence the foreign exchange rate of its currency, and to maintain confidence in financial markets. Reserves are held in one or more
reserve currencies
A reserve currency (or anchor currency) is a foreign currency that is held in significant quantities by central banks or other monetary authorities as part of their foreign exchange reserves. The reserve currency can be used in international tran ...
, nowadays mostly the
United States dollar
The United States dollar (symbol: $; code: USD; also abbreviated US$ or U.S. Dollar, to distinguish it from other dollar-denominated currencies; referred to as the dollar, U.S. dollar, American dollar, or colloquially buck) is the official ...
and to a lesser extent the
euro
The euro (symbol: €; code: EUR) is the official currency of 19 out of the member states of the European Union (EU). This group of states is known as the eurozone or, officially, the euro area, and includes about 340 million citizens . ...
.
Foreign exchange reserves assets can comprise
banknotes,
bank deposits, and
government securities of the reserve currency, such as
bonds and
treasury bills. Some countries hold a part of their reserves in
gold
Gold is a chemical element with the symbol Au (from la, aurum) and atomic number 79. This makes it one of the higher atomic number elements that occur naturally. It is a bright, slightly orange-yellow, dense, soft, malleable, and ductile ...
, and
special drawing rights
Special drawing rights (SDRs, code ) are supplementary foreign exchange reserve assets defined and maintained by the International Monetary Fund (IMF). SDRs are units of account for the IMF, and not a currency ''per se''. They represent a claim ...
are also considered reserve assets. Often, for convenience, the cash or securities are retained by the central bank of the reserve or other currency and the "holdings" of the foreign country are tagged or otherwise identified as belonging to the other country without them actually leaving the vault of that central bank. From time to time they may be physically moved to the home or another country.
Normally, interest is not paid on foreign cash reserves, nor on gold holdings, but the central bank usually earns interest on government securities. The central bank may, however, profit from a depreciation of the foreign currency or incur a loss on its appreciation. The central bank also incurs opportunity costs from holding the reserve assets (especially cash holdings) and from their storage, security costs, etc.
Definition
Foreign exchange reserves are also known as reserve assets and include foreign
banknote
A banknote—also called a bill (North American English), paper money, or simply a note—is a type of negotiable instrument, negotiable promissory note, made by a bank or other licensed authority, payable to the bearer on demand.
Banknotes w ...
s, foreign bank deposits, foreign
treasury bills, and short and long-term foreign government securities, as well as
gold reserves,
special drawing rights
Special drawing rights (SDRs, code ) are supplementary foreign exchange reserve assets defined and maintained by the International Monetary Fund (IMF). SDRs are units of account for the IMF, and not a currency ''per se''. They represent a claim ...
(SDRs), and
International Monetary Fund
The International Monetary Fund (IMF) is a major financial agency of the United Nations, and an international financial institution, headquartered in Washington, D.C., consisting of 190 countries. Its stated mission is "working to foster gl ...
(IMF) reserve positions.
In a central bank's accounts, foreign exchange reserves are called
reserve asset
In international economics, the balance of payments (also known as balance of international payments and abbreviated BOP or BoP) of a country is the difference between all money flowing into the country in a particular period of time (e.g., ...
s in the
capital account of the
balance of payments, and may be labeled as reserve assets under assets by functional category. In terms of financial assets classifications, reserve assets can be classified as
gold bullion, unallocated gold accounts, special drawing rights, currency, reserve position in the IMF, interbank position, other transferable deposits, other deposits,
debt securities,
loan
In finance, a loan is the lending of money by one or more individuals, organizations, or other entities to other individuals, organizations, etc. The recipient (i.e., the borrower) incurs a debt and is usually liable to pay interest on that ...
s,
stock
In finance, stock (also capital stock) consists of all the shares by which ownership of a corporation or company is divided.Longman Business English Dictionary: "stock - ''especially AmE'' one of the shares into which ownership of a company ...
s (listed and unlisted), investment fund shares and financial
derivative
In mathematics, the derivative of a function of a real variable measures the sensitivity to change of the function value (output value) with respect to a change in its argument (input value). Derivatives are a fundamental tool of calculus. ...
s, such as
forward contract
In finance, a forward contract or simply a forward is a non-standardized contract between two parties to buy or sell an asset at a specified future time at a price agreed on at the time of conclusion of the contract, making it a type of derivat ...
s and
options
Option or Options may refer to:
Computing
*Option key, a key on Apple computer keyboards
*Option type, a polymorphic data type in programming languages
* Command-line option, an optional parameter to a command
*OPTIONS, an HTTP request method
...
. There is no counterpart for reserve assets in liabilities of the International Investment Position. Usually, when the monetary authority of a country has some kind of liability, this will be included in other categories, such as Other Investments. On a central bank's
Balance sheet
In financial accounting, a balance sheet (also known as statement of financial position or statement of financial condition) is a summary of the financial balances of an individual or organization, whether it be a sole proprietorship, a busine ...
, foreign exchange reserves are assets, along with domestic credit.
Purpose
Typically, one of the critical functions of a country's central bank is reserve management, to ensure that the central bank has control over adequate foreign assets to meet national objectives. These objectives may include:
* supporting and maintaining confidence in the national monetary and exchange rate management policies,
* limiting external vulnerability to shocks during times of crisis or when access to borrowing is curtailed, and in doing so -
** providing a level of confidence to markets,
** demonstrating backing for the domestic currency,
** assisting the government to meet its foreign exchange needs and external debt obligations, and
** maintaining a reserve for potential national disasters or emergencies.
Reserves assets allow a central bank to purchase the domestic currency, which is considered a liability for the central bank (since it prints the money or
fiat currency
Fiat money (from la, fiat, "let it be done") is a type of currency that is not backed by any commodity such as gold or silver. It is typically designated by the issuing government to be legal tender. Throughout history, fiat money was sometim ...
as
IOUs). Thus, the quantity of foreign exchange reserves can change as a central bank implements
monetary policy
Monetary policy is the policy adopted by the monetary authority of a nation to control either the interest rate payable for very short-term borrowing (borrowing by banks from each other to meet their short-term needs) or the money supply, often ...
, but this dynamic should be analyzed generally in the context of the level of capital mobility, the
exchange rate regime and other factors. This is known as
trilemma or
impossible trinity
The impossible trinity (also known as the impossible trilemma or the Unholy Trinity) is a concept in international economics which states that it is impossible to have all three of the following at the same time:
* a fixed foreign exchange rate
...
. Hence, in a world of perfect capital mobility, a country with
fixed exchange rate
A fixed exchange rate, often called a pegged exchange rate, is a type of exchange rate regime in which a currency's value is fixed or pegged by a monetary authority against the value of another currency, a basket of other currencies, or another ...
would not be able to execute an independent monetary policy.
A central bank which chooses to implement a fixed exchange rate policy may face a situation where
supply and
demand
In economics, demand is the quantity of a good that consumers are willing and able to purchase at various prices during a given time. The relationship between price and quantity demand is also called the demand curve. Demand for a specific item ...
would tend to push the value of the currency lower or higher (an increase in demand for the currency would tend to push its value higher, and a decrease lower) and thus the central bank would have to use reserves to maintain its fixed exchange rate. Under perfect capital mobility, the change in reserves is a temporary measure, since the fixed exchange rate attaches the domestic monetary policy to that of the country of the
base currency. Hence, in the long term, the monetary policy has to be adjusted in order to be compatible with that of the country of the base currency. Without that, the country will experience outflows or inflows of capital.
Fixed pegs were usually used as a form of monetary policy, since attaching the domestic currency to a currency of a country with lower levels of inflation should usually assure convergence of prices.
In a pure flexible exchange rate regime or
floating exchange rate
In macroeconomics and economic policy, a floating exchange rate (also known as a fluctuating or flexible exchange rate) is a type of exchange rate regime in which a currency's value is allowed to fluctuate in response to foreign exchange ma ...
regime, the central bank does not intervene in the exchange rate dynamics; hence the exchange rate is determined by the market. Theoretically, in this case reserves are not necessary. Other instruments of monetary policy are generally used, such as interest rates in the context of an
inflation targeting regime.
Milton Friedman
Milton Friedman (; July 31, 1912 – November 16, 2006) was an American economist and statistician who received the 1976 Nobel Memorial Prize in Economic Sciences for his research on consumption analysis, monetary history and theory and the ...
was a strong advocate of flexible exchange rates, since he considered that independent monetary (and in some cases fiscal) policy and openness of the capital account are more valuable than a fixed exchange rate. Also, he valued the role of exchange rate as a price. As a matter of fact, he believed that sometimes it could be less painful and thus desirable to adjust only one price (the exchange rate) than the whole set of prices of
goods
In economics, goods are items that satisfy human wants
and provide utility, for example, to a consumer making a purchase of a satisfying product. A common distinction is made between goods which are transferable, and services, which are not ...
and
wage
A wage is payment made by an employer to an employee for work done in a specific period of time. Some examples of wage payments include compensatory payments such as ''minimum wage'', '' prevailing wage'', and ''yearly bonuses,'' and remun ...
s of the economy, that are less flexible.
Mixed exchange rate regimes (
'dirty floats', target bands or similar variations) may require the use of foreign exchange operations to maintain the targeted exchange rate within the prescribed limits, such as fixed exchange rate regimes.
As seen above, there is an intimate relation between exchange rate policy (and hence reserves accumulation) and monetary policy. Foreign exchange operations can be
sterilized (have their effect on the money supply negated via other financial transactions) or unsterilized.
Non-sterilization will cause an expansion or contraction in the amount of domestic currency in circulation, and hence directly affect
inflation
In economics, inflation is an increase in the general price level of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reductio ...
and monetary policy. For example, to maintain the same exchange rate if there is increased demand, the central bank can issue more of the domestic currency and purchase foreign currency, which will increase the sum of foreign reserves. Since (if there is no sterilization) the domestic money supply is increasing (money is being 'printed'), this may provoke domestic inflation. Also, some central banks may let the exchange rate appreciate to control inflation, usually by the channel of cheapening
tradable goods.
Since the amount of foreign reserves available to defend a weak currency (a currency in low demand) is limited, a
currency crisis
A currency crisis is a type of financial crisis, and is often associated with a real economic crisis. A currency crisis raises the probability of a banking crisis or a default crisis. During a currency crisis the value of foreign denominated debt ...
or
devaluation
In macroeconomics and modern monetary policy, a devaluation is an official lowering of the value of a country's currency within a fixed exchange-rate system, in which a monetary authority formally sets a lower exchange rate of the national cur ...
could be the end result. For a currency in very high and rising demand, foreign exchange reserves can theoretically be continuously accumulated, if the intervention is sterilized through
open market operations to prevent inflation from rising. On the other hand, this is costly, since the sterilization is usually done by
public debt instruments (in some countries Central Banks are not allowed to emit debt by themselves).
In practice, few central banks or currency regimes operate on such a simplistic level, and numerous other factors (domestic demand, production and
productivity
Productivity is the efficiency of production of goods or services expressed by some measure. Measurements of productivity are often expressed as a ratio of an aggregate output to a single input or an aggregate input used in a production proce ...
, imports and exports, relative prices of goods and services, etc.) will affect the eventual outcome. Besides that, the hypothesis that the world economy operates under perfect capital mobility is clearly flawed.
As a consequence, even those central banks that strictly limit foreign exchange interventions often recognize that currency markets can be volatile and may intervene to counter disruptive short-term movements (that may include
speculative attacks). Thus, intervention does not mean that they are defending a specific exchange rate level. Hence, the higher the reserves, the higher is the capacity of the central bank to smooth the
volatility of the Balance of Payments and assure
consumption smoothing Consumption smoothing is an economic concept for the practice of optimizing a person's standard of living through an appropriate balance between savings and consumption over time. An optimal consumption rate should be relatively similar at each sta ...
in the long term.
Reserve accumulation
After the end of the
Bretton Woods system
The Bretton Woods system of monetary management established the rules for commercial and financial relations among the United States, Canada, Western European countries, Australia, and Japan after the 1944 Bretton Woods Agreement. The Bret ...
in the early 1970s, many countries adopted flexible exchange rates. In theory reserves are not needed under this type of exchange rate arrangement; thus the expected trend should be a decline in foreign exchange reserves. However, the opposite happened and foreign reserves present a strong upward trend. Reserves grew more than
gross domestic product
Gross domestic product (GDP) is a money, monetary Measurement in economics, measure of the market value of all the final goods and services produced and sold (not resold) in a specific time period by countries. Due to its complex and subjec ...
(GDP) and imports in many countries. The only ratio that is relatively stable is foreign reserves over
M2.
[Rodrik, Dani. "The social cost of foreign exchange reserves." ''International Economic Journal'' 20.3 (2006): 253-266.] Below are some theories that can explain this trend.
Theories
Signaling or vulnerability indicator
Credit risk agencies and international organizations use ratios of reserves to other external sector variables to assess a country's external vulnerability. For example, Article IV of 2013 uses total
external debt
A country's gross external debt (or foreign debt) is the liabilities that are owed to nonresidents by residents. The debtors can be governments, corporations or citizens. External debt may be denominated in domestic or foreign currency. It incl ...
to gross international reserves, gross international reserves in months of prospective goods and nonfactor services imports to
broad money
In economics, broad money is a measure of the amount of money, or money supply, in a national economy including both highly liquid "narrow money" and less liquid forms. The European Central Bank, the OECD and the Bank of England all have their own ...
, broad money to short-term external debt, and short-term external debt to short-term external debt on residual maturity basis plus current account deficit. Therefore, countries with similar characteristics accumulate reserves to avoid negative assessment by the financial market, especially when compared to members of a
peer group
In sociology, a peer group is both a social group and a primary group of people who have similar interests ( homophily), age, background, or social status. The members of this group are likely to influence the person's beliefs and behaviour.
...
.
Precautionary aspect
Reserves are used as
savings
Wealth is the abundance of valuable financial assets or physical possessions which can be converted into a form that can be used for transactions. This includes the core meaning as held in the originating Old English word , which is from an ...
for potential times of crises, especially balance of payments crises. Original fears were related to the current account, but this gradually changed to also include financial account needs. Furthermore, the creation of the IMF was viewed as a response to the need of countries to accumulate reserves. If a specific country is suffering from a balance of payments crisis, it would be able to borrow from the IMF. However, the process of obtaining resources from the Fund is not automatic, which can cause problematic delays especially when markets are stressed. Therefore, the fund only serves as a provider of resources for longer term adjustments. Also, when the crisis is generalized, the resources of the IMF could prove insufficient. After the 2008 crisis, the members of the Fund had to approve a capital increase, since its resources were strained. Moreover, after the 1997 Asian crisis, reserves in Asian countries increased because of doubt in the IMF reserves. Also, during the 2008 crisis, the
Federal Reserve
The Federal Reserve System (often shortened to the Federal Reserve, or simply the Fed) is the central banking system of the United States of America. It was created on December 23, 1913, with the enactment of the Federal Reserve Act, after a ...
instituted
currency swap lines with several countries, alleviating liquidity pressures in dollars, thus reducing the need to use reserves.
=External trade
=
Countries engaging in
international trade
International trade is the exchange of capital, goods, and services across international borders or territories because there is a need or want of goods or services. (see: World economy)
In most countries, such trade represents a significan ...
, maintain reserves to ensure no interruption. A rule usually followed by central banks is to hold in reserve at least three months of imports. Also, an increase in reserves occurred when commercial openness increased (part of the process known as
globalization
Globalization, or globalisation (English in the Commonwealth of Nations, Commonwealth English; American and British English spelling differences#-ise, -ize (-isation, -ization), see spelling differences), is the process of foreign relation ...
). Reserve accumulation was faster than that which would be explained by trade, since the ratio has increased to several months of imports. Furthermore, the ratio of reserves to foreign trade is closely watched by credit risk agencies in months of imports.
=Financial openness
=
The opening of a financial account of the
balance of payments has been important during the last decade. Hence, financial flows such as
direct investment and
portfolio investment became more important. Usually financial flows are more volatile that enforce the necessity of higher reserves. Moreover, holding reserves, as a consequence of the increasing of financial flows, is known as
Guidotti–Greenspan rule The Guidotti–Greenspan rule is an international economics guideline that states that a country's reserves should equal short-term external debt (one-year or less maturity), implying a ratio of reserves-to-short term debt of 1. The rationale is th ...
that states a country should hold liquid reserves equal to their foreign liabilities coming due within a year. For example, international wholesale financing relied more on Korean banks in the aftermath of the 2008 crisis, when the Korean Won depreciated strongly, because the Korean banks' ratio of short-term external debt to reserves was close to 100%, which exacerbated the perception of vulnerability.
Exchange rate policy
Reserve accumulation can be an instrument to interfere with the exchange rate. Since the first
General Agreement on Tariffs and Trade
The General Agreement on Tariffs and Trade (GATT) is a legal agreement between many countries, whose overall purpose was to promote international trade by reducing or eliminating trade barriers such as tariffs or quotas. According to its ...
(GATT) of 1948 to the foundation of the
World Trade Organization
The World Trade Organization (WTO) is an intergovernmental organization that regulates and facilitates international trade. With effective cooperation
in the United Nations System, governments use the organization to establish, revise, and ...
(WTO) in 1995, the regulation of trade is a major concern for most countries throughout the world. Hence, commercial distortions such as subsidies and taxes are strongly discouraged. However, there is no global framework to regulate financial flows. As an example of regional framework, members of the
European Union
The European Union (EU) is a supranational political and economic union of member states that are located primarily in Europe. The union has a total area of and an estimated total population of about 447million. The EU has often been ...
are prohibited from introducing
capital controls, except in an extraordinary situation. The dynamics of
China's trade balance and reserve accumulation during the first decade of the 2000 was one of the main reasons for the interest in this topic.
Some economists are trying to explain this behavior. Usually, the explanation is based on a sophisticated variation of
mercantilism, such as to protect the take-off in the
tradable sector of an economy, by avoiding the real exchange rate appreciation that would naturally arise from this process. One attempt uses a standard model of open economy
intertemporal consumption
Economic theories of intertemporal consumption seek to explain people's preferences in relation to consumption and saving over the course of their lives. The earliest work on the subject was by Irving Fisher and Roy Harrod, who described 'hump ...
to show that it is possible to replicate a tariff on imports or a subsidy on exports by closing the capital account and accumulating reserves. Another is more related to the
economic growth literature. The argument is that the tradable sector of an economy is more capital intense than the non-tradable sector. The private sector invests too little in capital, since it fails to understand the social gains of a higher capital ratio given by
externalities
In economics, an externality or external cost is an indirect cost or benefit to an uninvolved third party that arises as an effect of another party's (or parties') activity. Externalities can be considered as unpriced goods involved in either co ...
(like improvements in human capital, higher competition, technological spillovers and increasing returns to scale). The government could improve the equilibrium by imposing
subsidies
A subsidy or government incentive is a form of financial aid or support extended to an economic sector (business, or individual) generally with the aim of promoting economic and social policy. Although commonly extended from the government, the ter ...
and
tariff
A tariff is a tax imposed by the government of a country or by a supranational union on imports or exports of goods. Besides being a source of revenue for the government, import duties can also be a form of regulation of foreign trade and p ...
s, but the hypothesis is that the government is unable to distinguish between good investment opportunities and
rent-seeking
Rent-seeking is the act of growing one's existing wealth without creating new wealth by manipulating the social or political environment.
Rent-seeking activities have negative effects on the rest of society. They result in reduced economic effic ...
schemes. Thus, reserves accumulation would correspond to a loan to foreigners to purchase a quantity of tradable goods from the economy. In this case, the real exchange rate would depreciate and the growth rate would increase. In some cases, this could improve welfare, since the higher growth rate would compensate the loss of the tradable goods that could be consumed or invested. In this context, foreigners have the role to choose only the useful tradable goods sectors.
Intergenerational savings
Reserve accumulation can be seen as a way of "forced savings". The government, by closing the financial account, would force the private sector to buy
domestic debt for lack of better alternatives. With these resources, the government buys foreign assets. Thus, the government coordinates the savings accumulation in the form of reserves.
Sovereign wealth fund
A sovereign wealth fund (SWF), sovereign investment fund, or social wealth fund is a state-owned investment fund that invests in real and financial assets such as stocks, bonds, real estate, precious metals, or in alternative investments such as ...
s are examples of governments that try to save the windfall of booming exports as long-term assets to be used when the source of the windfall is extinguished.
Costs
There are costs in maintaining large currency reserves. Fluctuations in
exchange rates result in gains and losses in the value of reserves. In addition, the purchasing power of
fiat money
Fiat money (from la, fiat, "let it be done") is a type of currency that is not backed by any commodity such as gold or silver. It is typically designated by the issuing government to be legal tender. Throughout history, fiat money was sometim ...
decreases constantly due to devaluation through inflation. Therefore, a central bank must continually increase the amount of its reserves to maintain the same power to manage exchange rates. Reserves of foreign currency may provide a small return in
interest
In finance and economics, interest is payment from a borrower or deposit-taking financial institution to a lender or depositor of an amount above repayment of the principal sum (that is, the amount borrowed), at a particular rate. It is disti ...
. However, this may be less than the reduction in purchasing power of that currency over the same period of time due to inflation, effectively resulting in a negative return known as the "quasi-fiscal cost". In addition, large currency reserves could have been invested in higher yielding assets.
Several calculations have been attempted to measure the cost of reserves. The traditional one is the spread between government debt and the yield on reserves. The caveat is that higher reserves can decrease the perception of risk and thus the government bond interest rate, so this measures can overstate the cost. Alternatively, another measure compares the yield in reserves with the alternative scenario of the resources being invested in capital stock to the economy, which is hard to measure. One interesting
measure tries to compare the spread between short term foreign borrowing of the private sector and yields on reserves, recognizing that reserves can correspond to a transfer between the private and the public sectors. By this measure, the cost can reach 1% of GDP to developing countries. While this is high, it should be viewed as an insurance against a crisis that could easily cost 10% of GDP to a country. In the context of theoretical economic models it is possible to simulate economies with different policies (accumulate reserves or not) and directly compare the welfare in terms of consumption. Results are mixed, since they depend on specific features of the models.
A case to point out is that of the
Swiss National Bank
The Swiss National Bank (SNB; german: Schweizerische Nationalbank; french: Banque nationale suisse; it, Banca nazionale svizzera; rm, Banca naziunala svizra) is the central bank of Switzerland, responsible for the nation's monetary policy a ...
, the central bank of Switzerland. The Swiss franc is regarded as a
safe haven currency, so it usually appreciates during market's stress. In the aftermath of the 2008 crisis and during the initial stages of the
Eurozone crisis, the
Swiss franc (CHF) appreciated sharply. The central bank resisted appreciation by buying reserves. After accumulating reserves during 15 months until June 2010, the SNB let the currency appreciate. As a result, the loss with the devaluation of reserves just in 2010 amounted to CHF 27 Billion or 5% of GDP (part of this was compensated by the profit of almost CHF6 Billion due to the surge in the price of gold). In 2011, after the currency appreciated against the Euro from 1.5 to 1.1, the SNB announced a ceiling at the value of CHF 1.2. In the middle of 2012, reserves reached 71% of GDP.
History
Origins and Gold Standard Era
The modern exchange market as tied to the prices of gold began during 1880. Of this year the countries significant by size of reserves were
Austria-Hungary
Austria-Hungary, often referred to as the Austro-Hungarian Empire,, the Dual Monarchy, or Austria, was a constitutional monarchy and great power in Central Europe between 1867 and 1918. It was formed with the Austro-Hungarian Compromise of ...
, Belgium,
Canadian Confederation
Canadian Confederation (french: Confédération canadienne, link=no) was the process by which three British North American provinces, the Province of Canada, Nova Scotia, and New Brunswick, were united into one federation called the Dominion ...
, Denmark,
Grand Duchy of Finland
The Grand Duchy of Finland ( fi, Suomen suuriruhtinaskunta; sv, Storfurstendömet Finland; russian: Великое княжество Финляндское, , all of which literally translate as Grand Principality of Finland) was the predecess ...
,
German Empire and
Sweden-Norway
Sweden and Norway or Sweden–Norway ( sv, Svensk-norska unionen; no, Den svensk-norske union(en)), officially the United Kingdoms of Sweden and Norway, and known as the United Kingdoms, was a personal union of the separate kingdoms of Sweden ...
.
Official international reserves, the means of official international payments, formerly consisted only of gold, and occasionally silver. But under the Bretton Woods system, the US dollar functioned as a reserve currency, so it too became part of a nation's official international reserve assets. From 1944–1968, the US dollar was convertible into gold through the Federal Reserve System, but after 1968 only central banks could convert dollars into gold from official gold reserves, and after 1973 no individual or institution could convert US dollars into gold from official gold reserves. Since 1973, no major currencies have been convertible into gold from official gold reserves. Individuals and institutions must now buy gold in private markets, just like other commodities. Even though US dollars and other currencies are no longer convertible into gold from official gold reserves, they still can function as official international reserves.
Central banks throughout the world have sometimes cooperated in buying and selling official international reserves to attempt to influence exchange rates and avert financial crisis. For example, in the
Baring crisis (the "Panic of 1890"), the
Bank of England borrowed GBP 2 million from the
Banque de France
The Bank of France (French: ''Banque de France''), headquartered in Paris, is the central bank of France. Founded in 1800, it began as a private institution for managing state debts and issuing notes. It is responsible for the accounts of the Fr ...
. The same was true for the
Louvre Accord and the
Plaza Accord
The Plaza Accord was a joint–agreement signed on September 22, 1985, at the Plaza Hotel in New York City, between France, West Germany, Japan, the United Kingdom, and the United States, to depreciate the U.S. dollar in relation to the Fre ...
in the post gold-standard era.
Post Gold Standard Era
Historically, especially before the
1997 Asian financial crisis, central banks had rather meager reserves (by today's standards) and were therefore subject to the whims of the market, of which there was accusations of
hot money manipulation, however Japan was the exception. In the case of Japan, forex reserves began their ascent a decade earlier, shortly after the
Plaza Accord
The Plaza Accord was a joint–agreement signed on September 22, 1985, at the Plaza Hotel in New York City, between France, West Germany, Japan, the United Kingdom, and the United States, to depreciate the U.S. dollar in relation to the Fre ...
in 1985, and were primarily used as a tool to weaken the surging
yen.
This effectively granted the United States a massive loan as they were almost exclusively invested in
US Treasuries, which assisted the US to engage the
Soviet Union
The Soviet Union,. officially the Union of Soviet Socialist Republics. (USSR),. was a List of former transcontinental countries#Since 1700, transcontinental country that spanned much of Eurasia from 1922 to 1991. A flagship communist state, ...
in an arms race which ended with the latter's bankruptcy, and at the same time, turned Japan into the world's largest creditor and the US the largest debtor, as well as swelled Japan's domestic debt (Japan sold its own currency to fund the buildup of dollar based assets). By end of 1980, foreign assets of Japan were about 13% of GDP but by the end of 1989 had reached an unprecedented 62%.
After 1997, nations in East and Southeast Asia began their massive build-up of forex reserves, as their levels were deemed too low and susceptible to the whims of the market credit bubbles and busts. This build-up has major implications for today's developed world economy, by setting aside so much cash that was piled into US and European debt, investment had been
crowded out, the developed world economy had effectively slowed to a crawl, giving birth to contemporary
negative interest rates.
By 2007, the world had experienced yet another financial crisis, this time the US Federal Reserve organized
central bank liquidity swaps with other institutions. Developed countries authorities adopted extra expansionary monetary and fiscal policies, which led to the appreciation of currencies of some
emerging markets. The resistance to appreciation and the fear of lost
competitiveness
In economics, competition is a scenario where different economic firmsThis article follows the general economic convention of referring to all actors as firms; examples in include individuals and brands or divisions within the same (legal) firm ...
led to policies aiming to prevent inflows of capital and more accumulation of reserves. This pattern was called
currency war by an exasperated Brazilian authority, and again in 2016 followed the
commodities collapse, Mexico had warned China of triggering currency wars.
Adequacy and excess reserves
The IMF proposed a new metric to assess reserves adequacy in 2011. The metric was based on the careful analysis of sources of outflow during crisis. Those liquidity needs are calculated taking in consideration the
correlation
In statistics, correlation or dependence is any statistical relationship, whether causal or not, between two random variables or bivariate data. Although in the broadest sense, "correlation" may indicate any type of association, in statisti ...
between various components of the balance of payments and the probability of tail events. The higher the ratio of reserves to the developed metric, the lower is the risk of a crisis and the drop in consumption during a crisis. Besides that, the Fund does
econometric analysis of several factors listed above and finds those reserves ratios are generally adequate among emerging markets.
Reserves that are above the adequacy ratio can be used in other government funds invested in more risky assets such as sovereign wealth funds or as insurance to time of crisis, such as
stabilization funds. If those were included,
Norway
Norway, officially the Kingdom of Norway, is a Nordic country in Northern Europe, the mainland territory of which comprises the western and northernmost portion of the Scandinavian Peninsula. The remote Arctic island of Jan Mayen and t ...
,
Singapore
Singapore (), officially the Republic of Singapore, is a sovereign island country and city-state in maritime Southeast Asia. It lies about one degree of latitude () north of the equator, off the southern tip of the Malay Peninsula, borde ...
and
Persian Gulf States would rank higher on these lists, and
United Arab Emirates
The United Arab Emirates (UAE; ar, اَلْإِمَارَات الْعَرَبِيَة الْمُتَحِدَة ), or simply the Emirates ( ar, الِْإمَارَات ), is a country in Western Asia ( The Middle East). It is located at ...
' estimated $627 billion
Abu Dhabi Investment Authority would be second after China. Apart from high foreign exchange reserves, Singapore also has significant government and sovereign wealth funds including
Temasek Holdings
Temasek Holdings (Private) Limited, or simply Temasek, is a Singaporean state holding company owned by the Government of Singapore. Incorporated on 25 June 1974, Temasek owns and manages a total of US$496.59 billion (S$671 billion) in assets u ...
(last valued at US$375 billion) and
GIC Private Limited
GIC Private Limited is a sovereign wealth fund in Singapore that manages its foreign reserves. Established by the Government of Singapore in 1981 as the Government of Singapore Investment Corporation, its mission is to preserve and enhance th ...
(last valued at US$440 billion).
ECN is a unique electronic communication network that links different participants of the Forex market: banks, centralized exchanges, other brokers and companies and private investors.
List of countries by foreign-exchange reserves
List of countries by foreign-exchange reserves (excluding gold)
See also
*
Balance of payments
*
Endaka
*
Foreign-exchange reserves of China
*
Foreign-exchange reserves of India
*
International Reserves of the Russian Federation
*
Foreign exchange market
The foreign exchange market (Forex, FX, or currency market) is a global decentralized or over-the-counter (OTC) market for the trading of currencies. This market determines foreign exchange rates for every currency. It includes all as ...
*
Global assets under management
Global assets under management consists of assets held by asset management firms, pension funds, sovereign wealth funds, hedge funds, and private equity funds
A private equity fund (abbreviated as PE fund) is a collective investment scheme us ...
References
External links
Sources
The World Factbook, CIA*
ttp://www.bcb.gov.br/?DAILYRESERVES Central Bank of Brazil – Daily updated foreign exchange reservesBank of Korea's top ten foreign exchange reserves holding countries monthly
Hong Kong Official Reserves Ranking
Articles
Guidelines for foreign exchange reserve managementAccompanying Document 1Document 2Appendix
* "
'" published by th
International Business Times AU
on 11 February 2011
A primer on exchange reserves
An empirical analysis of foreign exchange reserves in emerging Asia – December 2005
Foreign exchange reserves: issues in asia – January 2005
Foreign exchange reserves in east asia: why the high demand? – 25 April 2003
Optimal currency shares in international reserves
Are high foreign exchange reserves in emerging markets a blessing or a burden?
The adequacy of foreign exchange reserves
Are changes in foreign exchange reserves well correlated with official intervention?
Foreign exchange reserves buildup: business as usual
Compositional Analysis Of Foreign Currency Reserves In The 1999–2007 Period. The Euro Vs. The Dollar As Leading Reserve Currency
Speeches
Y V Reddy: India's foreign exchange reserves – policy, status and issues – 10 May 2002Marion Williams: foreign exchange reserves – how much is enough? – 2 November 2005
Books
* Eichengreen, Barry. Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System. Oxford University Press, USA, 2011.
{{DEFAULTSORT:Foreign Exchange Reserves
International macroeconomics
Macroeconomic indicators
Government finances