Reserve Currency

12 Key excerpts on "Reserve Currency"

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  The Exorbitant Burden

  The Impact of the U.S. Dollar's Reserve and Global Currency Status on the U.S. Twin-Deficits

  • Taranza T. Ganziro, Robert G. Vambery(Authors)
  • 2016(Publication Date)
  • Emerald Group Publishing Limited

    (Publisher)

  As the Reserve Currency-denominated assets becomes more and more liquid with deep and sophisticated markets, the reserve cur-rency becomes the most indicated currency to serve as a global unit of account that support economic calculations in the world economy such as trade, a medium of international exchange, and a store of value for government debt instruments like treasury bonds. It is important to distinguish as Kenen (2011) noted between a Currency Internationalization, which refers to a currency ’ s wide use outside the issuer ’ s borders, and a Reserve Currency status. He argued that the currency internationalization can be easily achieved 10 THE EXORBITANT BURDEN through an increased settlement of cross-border and international trade transactions along with bilateral currency swap agreements. However, Reserve Currency status is rather a longer-term and more dif fi cult goal to achieve because other fundamentals such as geopolitical strength, deeper fi nancial markets, liberalization of the capital account, currency mobility or convertibility, willingness of foreign of fi cial and private players to hold the currency are very important factors in determining the Reserve Currency status which goes far beyond macroeconomic balance sheet and trade networks. Based on the above principles, only four currencies U.S. dollar, Euro, British Pound, and Japanese Yen that make the Special Drawing Right (SDR) currency basket and recognized by the International Monetary Fund (IMF) as freely exchanged globally and widely traded on major exchange markets worldwide and which account for 95% of allocated global international reserves, are viewed by many economists such as Maziad et al. (2011) are truly global reserve currencies. Yap (2011) placed the U.S.

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  Problems of international Money, 1972-85

  • International Monetary Fund(Author)
  • 1996(Publication Date)
  • INTERNATIONAL MONETARY FUND

    (Publisher)

  This way of looking at the problem introduces a number of interesting questions about the provision and composition of reserve holdings in the current system. A general review of recent developments in the pattern of reserve holdings reinforces the view that the apparent relationships between reserve holdings and other important economic variables have continued to conform to historical experience. However, there are alternative interpretations of these developments. While it may have been useful in the past to interpret reserve holdings as being demand determined, this is not a useful interpretation in the current system. The view that reserve holdings are, for most countries, an element in a more general financial strategy is developed further in the final section of this paper in the context of the management of the currency composition of reserve assets.

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  Comment

  Willem H. Buiter Dooley has written a characteristically lucid paper on a subject matter for which clarity has a significant scarcity premium: the changing role and significance of international reserves.

  The exchange rate systems he compares are an idealized gold standard (a system with an exogenously given quantity of international reserves) and a fixed exchange rate system without convertibility into an “outside” reserve asset. While the paper is not clear on the matter, I assume this means a system comprising a few Reserve Currency countries and a large number of small non-Reserve Currency countries. Some of the latter can borrow in the international financial markets to replenish their reserves while others are credit constrained.

  The paper has very little to say about the “microfoundations” of the demand for and supply of international reserves and for the purposes of this discussion I also merely assume the existence of a reasonably stable demand function for international reserves as well as the usual well-behaved demand functions for domestic money.

  Four main points are made by Dooley. First, for the authority of an individual country, international creditworthiness implies the ability to borrow international reserves in private financial markets. The supply schedule of international reserves to an individual creditworthy country is highly elastic; for simplicity it can be viewed as perfectly elastic, or horizontal. The opportunity cost of international reserves is measured by the spread between the marginal cost of obtaining external credit and the rate of return earned on the reserve assets.

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  Asia In The Global Economy: Finance, Trade And Investment

  Finance, Trade and Investment

  • Ramkishen S Rajan, Sunil Rongala(Authors)
  • 2008(Publication Date)
  • World Scientific

    (Publisher)

  The choice of reserve asset by developing countries continues to be influenced by a dense web of exchange rate, financial, and com-mercial links with the reserve-currency countries, which itself continues to develop gradually over time. To be sure, there are ongoing changes in these relationships and policies … (b)ut these are evolutionary processes, which again suggests that the currency composition of reserves will change gradually, not discontinuously. There are plenty of potential sources of instability affecting exchange rates and the international mon-etary system. But … instability in the demand for reserves seems unlikely to be one of them.” 9 While there may be some concern about the store of value function of the USD over time, the US economy will have to significantly underper-form the rest of the world on a sustained basis for it to lose its global dol-lar hegemony. Indeed, given the desire by central banks and other investors for greater yield on their reserves, it is possible that they will choose to shift more of their assets into longer yielding US assets rather than into other currencies. As such, while accepting the possibility of cap-ital losses (in the event of a longer term decline in the USD), investors are at least being partly compensated for taking on greater liquidity risk by extending the duration of their portfolios. As noted by an analyst from Morgan Stanley: “(A)s central banks shift from a traditional liquidity management posture to a return-enhancing investment strategy, reserve diversification … does not necessarily mean USD selling or USD weakness … The US corporate bond market accounts for close to three times the corporate bond market in euroland, and 3.5 times as big as in Japan. In fact, this market is bigger than the other corporate bond markets combined. Similarly, the total mar-ket cap of the US equity market is dominant, 2.5–3 times bigger than the markets in euroland or Japan.

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  Analytical Gains of Geopolitical Economy

  • Radhika Desai, Paul Zarembka(Authors)
  • 2016(Publication Date)
  • Emerald Group Publishing Limited

    (Publisher)

  The “theoretical justification for this approach was never strong; the central problem was one of defining the optimum value of the R/M [reserves to imports] ratio” ( Bird & Rajan, 2003 , p. 876). On the other hand, the most prominent uses of reserves that the litera-ture proposes are the following. First, foreign exchange should be kept to anticipate sudden massive outflows of capital and avoid crisis that would induce output losses and investment contractions. “Absent speedy and credible help from an international lender of last resort, rapid outflows of this type would be difficult to manage without a large war chest” ( Obstfeld, Shambaugh, & Taylor, 2008 , p. 6). Reserves do function in this form as self-insurance ( Aizenman, 2008 ) and in the evolution of the current crisis they have proved indispensable for contender states in absorbing the effects of currency outflows. In practice, in the post-Bretton Woods era, no matter what scheme a country chose to enable wider acceptance of its currency pegging to 94 GEORGE LABRINIDIS a quasi-world money (primarily the US dollar, but also the British Pound and the French Franc), floating or something in between the necessity of foreign exchange was evident. In order for most economies to stabilize their currency, the central bank has to intervene when there is undue pressure on their currencies, buying or selling USD ( Eichengreen, 1996 ). This process has been emphasized through the crises of the IMS that are known as cur-rency crises. 5 “Currency crises [ … ] have become a defining force for eco-nomic policy in much of the world” ( Krugman, 2000 , p. 1). In the case of export-oriented countries, and to the degree that conten-der states’ exports were gaining in significance, supporting the dollar and keeping it, if possible, overvalued relative to their currencies became a widespread strategy. The reasons that lie behind this strategy are multiple and quite apparent.

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  A Systems Perspective on Financial Systems

  • Jeffrey Yi-Lin Forrest(Author)
  • 2014(Publication Date)
  • CRC Press

    (Publisher)

  In terms of the management of different currencies, it is about how to select and adjust promptly the weights of various reserve currencies in the overall foreign exchange reserve. Differences in the exchange rates and interest rates of the reserve currencies and changes in these rates lead to uncertainties and differences in the return of the reserve assets held in these currencies. Hence, when the monetary authority of a nation arranges the composite of reserve currencies, it mainly considers the exchange rate risk and interest rate risk as may be caused by the fluctuations in the exchange rates and interest rates. Speaking more specifically, in order to reduce the exchange rate risk, the currency selection in the management of reserve currencies is done mainly by considering the following factors: (i) the currencies to be used in foreign trades; (ii) the currencies needed to repay foreign debts; (iii) the currencies the government will use when it needs to intervene with the foreign exchange market in order to stabilize the exchange rates; (iv) the comparison of the changes in the interest rates of var-ious reserve currencies and the changes in the relevant exchange rates; and (v) the diversification of reserve currencies. In terms of the asset structure of foreign exchange reserve, it means the combina-torial proportions of such foreign currency assets as cash, deposits, priced short-term and long-term bonds, etc., in the foreign exchange reserve. In order to make the employment of foreign exchange reserve satisfy collectively the requirements of liquid-ity, safety, and profitability, the management of foreign exchange reserve, in general, is done hierarchically based on how conveniently each asset class can be converted into cash, while determining the appropriate proportions of the hierarchies.

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  Economics of the International Financial System

  • Sukumar Nandi(Author)
  • 2017(Publication Date)
  • Taylor & Francis

    (Publisher)

  The arguments that the developing countries have greater need for holding and maintaining international reserve for a number of reasons (instability in price of raw materials, instability of balance of payments, etc.) are well established in the literature. Also factors like rigidities introduced by debt payments, volatility in the prices of primary factors in trade, and the inability of the poorer countries to attract short-term capital inflow, all these justify the greater need for maintaining higher reserve for the developing countries.

  14.4  Reasons for Holding Reserve

  Though in normal circumstances a country should hold a certain amount of reserve, the holding of it is not costless. The opportunity cost of holding reserve is the differential income the country is to forego, which is the difference between the productivity of capital when invested domestically and the interest earned through the holding of the reserve. Still, there are important reasons why reserve should be held. At least three reasons are cited in the literature.

  First, holding of reserve gives credibility to the monetary authority regarding financial strength. A visible strong financial position will prevent flight from the currency, whether it is by residents or non-resident creditors who might otherwise be tempted to sell a currency short. Further, a national ‘fiat’ currency should be backed, at least partially, so that monetary authority remains ready to keep the promise of converting the liquidity liabilities (currency) into foreign exchange when desired. Also a large reserve enables the country to borrow foreign capital and enhance the liquidity by a multiplier if the country faces the possibility of capital flight.

  Second, a certain level of reserve of the country can be used against ‘the contingency that the country may some day want to absorb resources from the rest of the world at a time when it cannot borrow or liquidate other foreign asset’ (Cooper, 1968). These reasons for holding reserve refer to exceptional circumstances when normal internal or external economic relationship comes to the point of breakdown.

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  Central Banks at a Crossroads

  What Can We Learn from History?

  • Michael D. Bordo, Øyvind Eitrheim, Marc Flandreau, Jan F. Qvigstad(Authors)
  • 2016(Publication Date)
  • Cambridge University Press

    (Publisher)

  (2008), is not of revenue-seeking asset managers engaging in transactions on international capital markets as part of their search for revenue, but rather of institutions connected to the external sector and other central banks solely through fluctuations in their bullion reserve and the rules of convertibility. We argue in this paper that this traditional story is too simple. Central banks already possessed some policy room for maneuver even when reserves were held wholly or principally in specie and gold standard rules tied the note circulation to the bullion reserve (Eichengreen and Flandreau 1997 is our distillation of the point). There was an evolution in the reserve management practices in the course of the late nineteenth and twentieth centuries away from holding the reserve entirely in bullion toward holding also foreign exchange reserves and using them to intervene on foreign exchange markets. The result was to transform the ways in which central banks were connected to the global economy over this longue durée. 2 Paralleling this, the Federal Reserve has played an important role in shoring up dollar liquidity over and above its normal operations with U.S. financial institutions, including by lending directly to the U.S. subsidiaries of foreign financial institutions. A Century and a Half of Banks, Reserves, and Currencies 281 Although several previous studies have sketched the selected aspects of this story, much remains to be done in terms of tying successive periods together and illuminating longer term economic and institutional develop- ments. Ideally, one would want a consistent panel of central bank balance sheets spanning a long historical period. Unfortunately, much of the relevant data has been lost or remains cloistered in the archives. Some is still regarded as too sensitive to release; other data have been selectively weeded or destroyed.

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  Sovereign Assets and Liabilities Management

  • INTERNATIONAL MONETARY FUND(Author)
  • 2000(Publication Date)
  • INTERNATIONAL MONETARY FUND

    (Publisher)

  2

  This paper investigates the main statistical changes in foreign exchange reserves within the past few years. It then describes some significant changes that have taken place with regard to the objectives and investment policies of central banks. Finally, it points out some trends that could noticeably slow or even reverse these recent changes.

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  Evolution of Foreign Exchange Reserves

  Foreign exchange reserves have grown at an increasing rate in recent years, while the currency composition of reserves has remained relatively constant. This has coincided with the trend toward a more integrated global economy. In the years up to 1996, the nominal size of reserves in dollar terms increased at an average annual rate of 14.3 percent (11.3 percent in 1993, 14.8 percent in 1994, and 16.8 percent in 1995). The growth in reserves in 1994 and 1995 was at least two percentage points higher than the 1986–92 average annual growth rate of 12.9 percent. This growth in reserves has not been symmetric between industrialized countries and emerging market economies (see Figures 10.1 and 10.2 , and Table 10.1 ). From 1993 to 1995, industrialized countries experienced a slower growth in reserves than during the period from 1986 to 1992 (10.1 percent average annual growth rate against 11.2 percent), while over the same period, the foreign exchange reserves of emerging market economies grew at a rate of 18.7 percent—compared with 15.2 percent during the period from 1986 to 1992. As a consequence of this faster rate of growth, by the end of 1995, the total foreign exchange reserves of all central banks had reached a combined amount of $1,382 billion, of which $655 billion (47.4 percent) were held by central banks of industrialized countries and $727 billion (52.6 percent) were held by central banks of emerging market economies. Thus, the sharp growth in the reserves of developing countries has led to a major shift in the distribution of world reserves. Industrialized countries no longer hold the major portion of world foreign exchange reserves.3

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  Central Bank Reserves and Sovereign Wealth Management

  • A. Berkelaar, J. Coche, K. Nyholm, A. Berkelaar, J. Coche, K. Nyholm(Authors)
  • 2009(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  It seems that relative prices of various assets will find new steady states, which may have little in common with relative valuations seen in the twentieth century. We also expect that slowly, over time, US “exorbitant privilege” will be eliminated. Finally we consider global stability risks in the context of the new reserves management style adopted by central banks. We postulate that due to the increasingly global nature of shocks, as long as central banks and govern- ments in countries which are stakeholders of global imbalances focus their actions on maintaining global price and financial stability, central banks in smaller emerging markets can afford to improve reserve management with- out incurring additional stability risk. 4 Krzysztof Rybinski and Urszula Krynska 1.2 The origins of the sharp rise in foreign exchange reserves In 2007 foreign exchange reserves held by central banks and sovereign wealth funds likely topped 9 trillion dollars. According to IMF COFER (Currency Composition of Official Foreign Reserves) database central bank reserves stood at 6.4 trillion dollars at the end of 2007 and assets under management by SWFs were estimated at around 2.5–3 trillion dol- lars. 1 Oil prices will likely continue to rise in the next decade after the present global slowdown is over and China’s large trade surplus will take time to reverse amid the Chinese tradition of saving a large part of their income, which suggests that further growth of central bank and sover- eign wealth funds assets should be expected in the coming years. The large and unprecedented rise of foreign exchange reserves led to many attempts to explain the reasons behind this trend. In January 1999 Martin Feldstein, the President of the National Bureau of Economic Research, the famous US think tank, wrote an article in the aftermath of the Asian crisis arguing for the need to keep large foreign exchange reserves that would serve as source of protection, flexibility and trust.

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  The Foreign Exchange Matrix

  A new framework for understanding currency movements

  • Barbara Rockefeller, Vicki Schmelzer(Authors)
  • 2013(Publication Date)
  • Harriman House

    (Publisher)

  At some point, it is reasonable to assume that those crying wolf will be right and an actual wolf will appear, taking the form of a risk premium for US debt. In the viral way of market thinking, the premium can appear and grow huge before policy-makers can come together to take action. Politicians and voters have to make the choice between raising taxes and cutting spending, including defence spending. If defence spending is, indeed, cut, by how much does the US lose hard influence – the ability to send the Navy in the direction of any conflict where the US perceives it has a stake – and soft influence? No one knows. A gradual loss of power is more palatable and less shameful than a sudden one, but a sudden loss of power could easily come about in the form of China taking a military action contrary to US wishes and the US declining to engage in a showdown.

  Such an event would mark only a step, if a shocking one, on the road to the dollar losing Reserve Currency status. As noted at the beginning of this chapter, the primary function of a Reserve Currency issuer is to provide liquidity to the rest of the world and to act as a banker of last resort to all the other central banks. China does not get Reserve Currency status for the renminbi by winning a military showdown with the US if it does not also meet this condition. It is fine for China to make the renminbi a transaction medium for regional commercial transactions and other liberalisations, but it is not until China establishes swap lines with the other central banks and they are depended upon in a real, live crisis, that China will actually get Reserve Currency status, whatever its military capabilities.

  Evaluating China’s prospects as a Reserve Currency issuer

  We should probably assume that any rival for top Reserve Currency status needs to match the criteria that were used in selecting the dollar as the primary Reserve Currency at Bretton Woods in 1944. These are chiefly economic and political criteria, including not only the ability to lead but also the willingness. Ability resides in the size of the economy and the capabilities of the country’s institutions, especially the central bank. Willingness to lead is a political matter. The Reserve Currency issuer has to be willing to lend emergency funds to others who insult and demean it, for the greater good of greasing the world’s financial machinery.

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  The International Monetary System

  Highlights From Fifty Years Of Princeton's Essays In International Finance

  • Peter B Kenen(Author)
  • 2019(Publication Date)
  • Taylor & Francis

    (Publisher)

  Instead of accepting the preferences of governments, it seeks to evaluate them in the light of ultimate cri-teria. In any event, consensus between governments is unattainable, and the dictatorial judgments of economists may help to provide the basis of a reasonable compromise. Reserve changes generally exercise their effects on world real income through national monetary and fiscal policies, such as those affecting imports, capital exports, and exchange rates. There are some exceptions to this general rule. For example, such changes may act on the minds of private individuals by inspiring a greater or lesser degree of confi-dence in exchange stability. But even in this instance-and granting that hot-money movements have a direct impact on economic life-the ulti-mate effects on real income are largely mediated through national 1 International Liquidity: Ends and Means, Staff Papers, Vol. VIII ( 1960-61), pp. 439-463. 71 72 ]. Marcus Fleming policies. However, as is explained later, if reserve changes as such act through national policies, the processes through which reserves come into existence or are acquired by countries may act more directly on the level of monetary demand. CRITERIA FOR OPTIMIZATION Other things being equal, the higher the level of a country's reserves and the better its prospects of increasing them in the future, the more inclined the country will be to adopt policies that, inter alia, worsen its balance of payments. Thus, higher reserves will encourage a country to adopt more expan-sionary monetary and fiscal policies, relax restrictions on imports or even promote them, relax promotion of exports or even restrict them, relax restrictions on capital exports, restrict capital imports, be more willing to provide capital exports and aid in untied form, be more generous in the provision of foreign aid, or be less willing to devalue and more willing to revalue the rate of exchange.

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  Shaking the Invisible Hand

  Complexity, Endogenous Money and Exogenous Interest Rates

  • B. Moore(Author)
  • 2006(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  But it is more restrictive in flexible exchange rate regimes, where the uncertainty of future exchange rate value is greater. The need to assure the future value of the exchange rate, and the accompanying desire to accumulate increased reserves of foreign exchange, prevents governments from pursuing expansionary domestic policy, preventing internal balance from being attained. Keynes argued the restraint on expansionary monetary and fiscal policies imposed by separate currencies was the major defect of using multinational currency standards. 20 Unlike the case of domestic currency, the accumulation of foreign exchange reserves has important opportunity costs. Foreign exchange reserves can be increased only by running surpluses on current account, or by borrowing on capital account. Countries not using the major currency as the domestic payments media are constrained from pursuing policies that increase the probability of a severe fall in their foreign exchange reserves in a fixed exchange rate regime, or would result in a severe fall in their exchange rate in a flexible exchange rate regime. As seen the use of multiple national currencies forces all countries, apart from the center, to pursue restrictive AD policies to ensure “external balance.” Protection of the foreign exchanges necessitates restrictive domestic policies, higher levels of interest rates, higher taxes, duties and quotas, and reduced government expendi- tures, all of which depress the level of domestic AD. The macroeconomic domestic policy objectives of full employment, more rapid capital formation, and more equal distribution of income must all be abandoned. So long as countries wish to trade with the rest of the world, they must avoid all policies that threaten their external balance since they must preserve the expected future conversion rate of their currency at the current rate.

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