Foreign Exchange Reserves


Foreign-exchange reserves (also called forex reserves or FX reserves) in a strict sense are ‘only’ the foreign financial institutions.

Contents

Purpose

In a citation needed]

Central banks throughout the world have sometimes cooperated in buying and selling [2]

Changes in reserves

The quantity of foreign exchange reserves can change as a central bank implements monetary policy.[3] A central bank that implements a fixed exchange rate policy may face a situation where supply and demand 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). In a flexible exchange rate regime, these operations occur automatically, with the central bank clearing any excess demand or supply by purchasing or selling the foreign currency. Mixed exchange rate regimes (‘dirty floats’, target bands or similar variations) may require the use of foreign exchange operations (sterilized or unsterilized[clarification needed]) to maintain the targeted exchange rate within the prescribed limits .

Foreign exchange operations that are unsterilized will cause an expansion or contraction in the amount of domestic currency in circulation, and hence directly affect monetary policy and inflation: An exchange rate target cannot be independent of an inflation target. Countries that do not target a specific exchange rate are said to have a floating exchange rate, and allow the market to set the exchange rate; for countries with floating exchange rates, other instruments of monetary policy are generally preferred and they may limit the type and amount of foreign exchange interventions. Even those central banks that strictly limit foreign exchange interventions, however, often recognize that currency markets can be volatile and may intervene to counter disruptive short-term movements.

To maintain the same exchange rate if there is increased demand, the central bank can issue more of the domestic currency and purchase the foreign currency, which will increase the sum of foreign reserves. In this case, the currency’s value is being held down; since (if there is no sterilization) the domestic money supply is increasing (money is being ‘printed’), this may provoke domestic inflation (the value of the domestic currency falls relative to the value of goods and services).

Since the amount of foreign reserves available to defend a weak currency (a currency in low demand) is limited, a foreign exchange crisis or devaluation could be the end result. For a currency in very high and rising demand, foreign exchange reserves can theoretically be continuously accumulated, although eventually the increased domestic money supply will result in inflation and reduce the demand for the domestic currency (as its value relative to goods and services falls). In practice, some central banks, through open market operations aimed at preventing their currency from appreciating, can at the same time build substantial reserves.

In practice, few central banks or currency regimes operate on such a simplistic level, and numerous other factors (domestic demand, production and productivity, imports and exports, relative prices of goods and services, etc.) will affect the eventual outcome. As certain impacts (such as inflation) can take many months or even years to become evident, changes in foreign reserves and currency values in the short term may be quite large as different markets react to imperfect data.

Costs, benefits, and criticisms

Large reserves of foreign currency allow a government to manipulate exchange rates – usually to stabilize the foreign exchange rates to provide a more favorable economic environment. In theory the manipulation of foreign currency exchange rates can provide the stability that a speculative attacks on the domestic currency.

There are costs in maintaining large currency reserves. Fluctuations in exchange markets result in gains and losses in the purchasing power of reserves. In addition to fluctuations in exchange rates, the purchasing power of fiat money 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 manipulate exchange rates. Reserves of foreign currency provide a small return in interest. 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.

History

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, Belgium, Canada, Denmark, Finland, Germany and Sweden. [5]

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.

Excess reserves

Foreign exchange reserves are important indicators of ability to repay foreign debt and for currency defense, and are used to determine credit ratings of nations, however, other government funds that are counted as liquid assets that can be applied to liabilities in times of crisis include India is also planning to create its own investment firm from its foreign exchange reserves.

On May 2011, an estimated that Asia has $3.5 trillion of foreign reserves or is around two-thirds of the world’s reserves and a stark contrast to the indebtedness in many developed Western economies.[6]

List of countries by foreign-exchange reserves

Reserves of gold in 2006

The following is a list of the top largest systems by foreign exchange reserves:

Rank Country Billion USD (end of month)
1 People’s Republic of China $ 3,285 (Sep 2012)[7]
2  Japan $ 1,277 (Sep 2012)[8]
Eurozone $ 903 (Aug 2012)[10]
3  Saudi Arabia $ 614 (Aug 2012)[11]
4  Russia $ 530 (Oct 2012)[12]
5  Switzerland $ 525 (Sep 2012)[13]
6  Republic of China (Taiwan) $ 398 (Sep 2012)[14]
7  Brazil $ 378 (Oct 2012)[15]
8  South Korea $ 317 (Aug 2012)[16]
 Hong Kong $ 298 (Aug 2012)[16]
9  India $ 290 (Aug 2012)[16]
10  Germany $ 263 (Sep 2012)[16]

The following is a list of inter-governmental free-trade associations and supranational organizations.

Rank Country Billion USD (end of month)
European Economic Area $ 1 416 (Feb 2011)
European Union $ 1 356 (Feb 2011)

These few holders account for more than 60% of total world foreign currency reserves. The adequacy of the foreign exchange reserves is more often expressed not as an absolute level, but as a percentage of short-term foreign debt, money supply, or average monthly imports.

See also

References

  1. http://cneh09.dal.ca/Schenk_CNEH.pdf Catherine R. Schenk, Canadian Network for Economic History conference, 10/2009
  2. ^ http://conscience-sociale.blogspot.com/2011/06/how-to-replace-world-trade-reference.html
  3. ^ http://mpra.ub.uni-muenchen.de/14350/1/MPRA_paper_14350.pdf Compositional Analysis Of Foreign Currency Reserves In The 1999–2007 Period. The Euro Vs. The Dollar As Leading Reserve Currency
  4. ISBN 0262532603
  5. ISBN 1119994896
  6. ^ http://www.thejakartapost.com/news/2011/06/07/does-asia-need-imf.html
  7. ^ “Gold & Foreign Exchange Reserves”. People’s Bank of China. http://www.pbc.gov.cn/publish/html/2012s09.htm. Retrieved 13 May 2011.
  8. ^ “International Reserves / Foreign Currency Liquidity”. The Ministry of Finance of Japan. http://www.mof.go.jp/english/international_policy/reference/official_reserve_assets/index.htm. Retrieved 2011-03-30.
  9. ^ “ECB statistics”. European Central Bank. http://www.ecb.int/stats/external/reserves/html/index.en.html. Retrieved 21 April 2012.
  10. ^ “IMF statistics”. International Monetary Fund. http://www.imf.org/external/np/sta/ir/IRProcessWeb/data/EUA/eng/CUReua.HTM. Retrieved 21 April 2012.
  11. ^ Monthly Bulletin. Table 9. Saudi Arabian Monetary Agency. Note: Saudi riyal is pegged to U.S. Dollar at 3.75 riyals per.
  12. ^ “International Reserves of the Russian Federation”. http://www.cbr.ru/eng/hd_base/mrrf/main.asp?C_mes=12&C_year=2011&To_mes=12&To_year=2012&x=40&y=12&mode=%20Bank%20of%20Russia.
  13. ^ Swiss National Bank
  14. ^ “Central Bank of the Republic of China (Taiwan)”. http://www.cbc.gov.tw/public/data/Ebanking/ERESERVE-N.pdf.
  15. ^ “Official Daily Information of Brazilian Foreign-exchange Reserves”. Central-Bank-of-Brazil. http://www.bcb.gov.br/?DAILYRESERVES.
  16. ^ http://www.imf.org/external/np/sta/ir/IRProcessWeb/colist.aspx.

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