Foreign exchange reserves

Foreign exchange reserves are the foreign currency deposits held by central banks and monetary authorities. These are assets of the central banks which are held in different reserve currencies such as the dollar, euro and yen, and which are used to back its liabilities, e.g. the local currency issued, and the various bank reserves deposited with the central bank, by the government or financial institutions.
Contents
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* 1 History
* 2 Purpose
* 3 Costs and benefits
* 4 Levels
* 5 See also
* 6 External links
o 6.1 Articles
o 6.2 Data
o 6.3 Speeches

History

Reserves were formerly held only in gold, as official gold reserves. But under the Bretton Woods system, the United States pegged the dollar to gold, and allowed convertibility of dollars to gold. This effectively made dollars appear as good as gold. The U.S. later abandoned the gold standard, but the dollar has remained stable as a fiat currency, and it is still the most significant reserve currency. Central banks now typically hold large amounts of multiple currencies in reserve.

Purpose

In a non fixed exchange rate system, reserves allow a central bank to purchase the issued currency, exchanging its assets to reduce its liability. The purpose of reserves is to allow central banks an additional means to stabilise the issued currency from excessive volatility, and protect the monetary system from shock, such as from currency traders engaged in flipping. Large reserves are often seen as a strength, as it indicates the backing a currency has. Low or falling reserves may be indicative of an imminent bank run on the currency or default, such as in a currency crisis.

Central banks sometimes claim that holding large reserves is a security measure. This is true to the extent that a central bank can prop up its own currency by spending reserves. (This practice is essentially large-scale manipulation of the global currency market. Central banks have sometimes attempted this in the years since the 1971 collapse of Bretton Woods. A few times, multiple central banks have cooperated to attempt to manipulate exchange rates. It is unclear just how effective the practice is.) But often, very large reserves are not a hedge against inflation but rather a direct consequence of the opposite policy: the bank has purchased large amounts of foreign currency in order to keep its own currency relatively cheap.

Costs and benefits

On one hand, if a country desires to have a government-influenced exchange rate, then holding bigger reserves gives the country a bigger ability to manipulate the currency market. On the other hand, holding reserves does induce opportunity cost. The "quasi-fiscal costs" of holding reserves are the gap between the low-yield assets that returns managers typically hold, and the average cost of government debt in the country. In addition, many governments have suffered huge losses on the management of the reserves portfolio - all of which is ultimately fiscal. When there is a currency crisis and all reserves vanish, this is ultimately a fiscal cost. Even when there is no currency crisis, there can be a fiscal cost, as is taking place in 2005 and 2006 with China, which holds huge USD assets but the CNY has been continually appreciating.

Levels
Foreign exchange reserves by country
Foreign exchange reserves by country

At the end of 2004, 66% of the identified official foreign exchange reserves in the world were held in United States dollars and 25% in euros [1].
Monetary Authorities with the largest foreign reserves in 2007. Central Bank/Monetary Authority billion USD (end of month)
Flag of People's Republic of China People's Republic of China $1066 (December)1
Flag of Japan Japan $905 (February)
Flag of Russia Russia $317 (March 09)2
Flag of Republic of China Republic of China (Taiwan) $268 (February)
Flag of South Korea South Korea (South Korea) $243 (February)
Flag of India India $194 (March 09)3
Flag of Singapore Singapore $139 (February)
Flag of Hong Kong Hong Kong, China $136 (February)
Flag of Germany Germany $113 (January)
Flag of Brazil Brazil $107 (March 20)4

Note:

* Note 1: China updates its information quarterly.
* Note 2: Russia updates its information weekly and monthly.
* Note 3: India updates its information weekly.
* Note 4: Brazil updates its information daily.

These few holders account for more than 50% 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

* International reserve system
* Balance of payments
* Official gold reserves
* Reserve currency
* Special Drawing Rights

External links

Articles

* Guidelines for foreign exchange reserve management
* 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? -- April 25, 2003
* Optimal currency shares in international reserves
* The adequacy of foreign exchange reserves

Data

* IMF's data on current foreign exchange reserves of reporting countries
* Taiwan's Department of Investment Services data on foreign exchange reserves of major countries
* Bank of Korea's top ten foreign exchange reserves holding countries monthly

Speeches

* Alan Greenspan: discusses recent trends in the management of foreign exchange reserves -- April 29, 1999
* Y V Reddy: India’s foreign exchange reserves - policy, status and issues -- May 10, 2002
* Marion Williams: foreign exchange reserves - how much is enough? -- November 02, 2005