Description
This is a presentation explains whether it is good for a country to keep the foreign exchange reserves.
Exchange Reserves: Weapons or Insurance
Foreign Exchange Reserves
• Foreign exchange reserves (also called Forex reserves) are the foreign currency deposits and bonds held by central banks and monetary authorities. • Over the last decade, central banks around the world have quadrupled the size of their foreign exchange reserves. • China has multiplied its own stock by a factor of ten • Total reserves of sub-Sahara African countries have also risen by a factor of ten • Only exceptions to this worldwide phenomenon are the developed countries.
Largest Countries by Foreign Exchange Reserves
Rank 1 2 3 4 5 6 7 8 9 10 Country China Japan Russia Taiwan India South Korea Brazil Hong Kong Germany Singapore Billion USD (Dec 2009) $ 2400 $ 1019 $ 441 $ 348 $ 279 $ 271 $ 245 $ 240 $ 184 $ 182
These holders account for more than 60% of total world foreign currency reserves
Reasons for Accumulation of Forex Reserves
• After the Asian Financial crisis, developing countries felt they cannot rely on the IMF or reforms in the “international financial architecture” to protect themselves from such crisis • Countries with higher (net) levels of liquid foreign assets are better able to withstand panics in financial markets and sudden reversals in capital flows • Liquidity, in turn, could be achieved via three strategies: reducing short-term debt, creating a collateralized credit facility, and increasing foreign exchange reserves of the Central Bank • Increased commercial openness of developing countries.
Is it restricted to emerging economy
Cost of holding forex reserves
• Developing nations have concentrated more on building forex reserves rather than reducing short-term debt • Amount spent in building up foreign exchange reserves could have been spent on increasing the production capacities of the developing countries • Fluctuations in exchange markets result in gains and losses in the purchasing power of reserves • The purchasing power of money decreases constantly due to devaluation through inflation
How China’s forex reserves got so large
• Reserves started growing when China pegged its currency (the renminbi or yuan) to the U.S. dollar in 1994 • Allowed Chinese products to remain low cost and affordable to overseas buyers • This in turn boosted exports, which allowed the Chinese economy to grow at a high rate of around 9%-10% it has in the last decade • As China’s economy surged ahead in the last 5-10 years, but the exchange rate remained pegged to the dollar, dollars have stacked up in the Chinese banking system
Overexpansion
• China’s inflexible and undervalued currency regime have led and continue to lead to domestic monetary expansion as the excess capital is reinvested in industrial production • Since production outpaces consumption, the trade surplus naturally increases, which feeds monetary expansion, starting the cycle all over again. • Besides the growth in exports, China has also seen a burst of manufacturing productivity which have all contributed to the excess liquidity in the economy.
Impact of forex reserves in china
• In China, all the dollars from exports that need to be converted to RMB is causing inflation • As demand for the yuan increases, rather than let the value of the yuan rise too quickly, Beijing is printing up new money instead • As China’s monetary system cannot absorb all the extra cash, prices have risen as a result and the stock and real estate markets have become inflated.
Impact of forex reserves on America
• China’s investment of its excess foreign reserves in U.S. Treasury bills, has effectively helped to finance the U.S. current account deficit – the result of a low savings rate and government spending that far exceeds its income • This massive “loan” from China has effectively helped the U.S. government to do everything from waging wars in Iraq and Afghanistan, to paying Congressional salaries, etc. • In turn, China has had a safe place to park its excess dollars
Is this an Ideal situation for America?
• The U.S. government was running a global current account deficit of almost $800 billion, the largest it has ever been • In order to finance this deficit and its own foreign investments, the U.S. must import about $1 trillion of foreign capital every year or more than $4 billion every working day, which is simply unsustainable in the long run • America relying on money controlled by a foreign country - as of early 2008, foreigners now control over 40% of the U.S. national debt
Contd..
• Moving from dollar assets to other asset will depreciate its value • Selling of US treasury will indirectly hampers the real estate market. • China is unlikely to do adopt this option of diversifying its option of investment.
Key notes
• Developing countries have responded to financial globalization by over investing in reserve accumulation. • With the reserve accumulation leader as china. Now it is not hurting US but it is hurting china as well • Economist believe that China reserves will not grow exponential as they need to invest on infrastructure, health and education of poor. • US budget deficit could be reduced by generating greater domestic savings
References
• http://www.aasc.ucla.edu/uschina/trade_curr ency.shtml
Thank You
doc_394508309.pptx
This is a presentation explains whether it is good for a country to keep the foreign exchange reserves.
Exchange Reserves: Weapons or Insurance
Foreign Exchange Reserves
• Foreign exchange reserves (also called Forex reserves) are the foreign currency deposits and bonds held by central banks and monetary authorities. • Over the last decade, central banks around the world have quadrupled the size of their foreign exchange reserves. • China has multiplied its own stock by a factor of ten • Total reserves of sub-Sahara African countries have also risen by a factor of ten • Only exceptions to this worldwide phenomenon are the developed countries.
Largest Countries by Foreign Exchange Reserves
Rank 1 2 3 4 5 6 7 8 9 10 Country China Japan Russia Taiwan India South Korea Brazil Hong Kong Germany Singapore Billion USD (Dec 2009) $ 2400 $ 1019 $ 441 $ 348 $ 279 $ 271 $ 245 $ 240 $ 184 $ 182
These holders account for more than 60% of total world foreign currency reserves
Reasons for Accumulation of Forex Reserves
• After the Asian Financial crisis, developing countries felt they cannot rely on the IMF or reforms in the “international financial architecture” to protect themselves from such crisis • Countries with higher (net) levels of liquid foreign assets are better able to withstand panics in financial markets and sudden reversals in capital flows • Liquidity, in turn, could be achieved via three strategies: reducing short-term debt, creating a collateralized credit facility, and increasing foreign exchange reserves of the Central Bank • Increased commercial openness of developing countries.
Is it restricted to emerging economy
Cost of holding forex reserves
• Developing nations have concentrated more on building forex reserves rather than reducing short-term debt • Amount spent in building up foreign exchange reserves could have been spent on increasing the production capacities of the developing countries • Fluctuations in exchange markets result in gains and losses in the purchasing power of reserves • The purchasing power of money decreases constantly due to devaluation through inflation
How China’s forex reserves got so large
• Reserves started growing when China pegged its currency (the renminbi or yuan) to the U.S. dollar in 1994 • Allowed Chinese products to remain low cost and affordable to overseas buyers • This in turn boosted exports, which allowed the Chinese economy to grow at a high rate of around 9%-10% it has in the last decade • As China’s economy surged ahead in the last 5-10 years, but the exchange rate remained pegged to the dollar, dollars have stacked up in the Chinese banking system
Overexpansion
• China’s inflexible and undervalued currency regime have led and continue to lead to domestic monetary expansion as the excess capital is reinvested in industrial production • Since production outpaces consumption, the trade surplus naturally increases, which feeds monetary expansion, starting the cycle all over again. • Besides the growth in exports, China has also seen a burst of manufacturing productivity which have all contributed to the excess liquidity in the economy.
Impact of forex reserves in china
• In China, all the dollars from exports that need to be converted to RMB is causing inflation • As demand for the yuan increases, rather than let the value of the yuan rise too quickly, Beijing is printing up new money instead • As China’s monetary system cannot absorb all the extra cash, prices have risen as a result and the stock and real estate markets have become inflated.
Impact of forex reserves on America
• China’s investment of its excess foreign reserves in U.S. Treasury bills, has effectively helped to finance the U.S. current account deficit – the result of a low savings rate and government spending that far exceeds its income • This massive “loan” from China has effectively helped the U.S. government to do everything from waging wars in Iraq and Afghanistan, to paying Congressional salaries, etc. • In turn, China has had a safe place to park its excess dollars
Is this an Ideal situation for America?
• The U.S. government was running a global current account deficit of almost $800 billion, the largest it has ever been • In order to finance this deficit and its own foreign investments, the U.S. must import about $1 trillion of foreign capital every year or more than $4 billion every working day, which is simply unsustainable in the long run • America relying on money controlled by a foreign country - as of early 2008, foreigners now control over 40% of the U.S. national debt
Contd..
• Moving from dollar assets to other asset will depreciate its value • Selling of US treasury will indirectly hampers the real estate market. • China is unlikely to do adopt this option of diversifying its option of investment.
Key notes
• Developing countries have responded to financial globalization by over investing in reserve accumulation. • With the reserve accumulation leader as china. Now it is not hurting US but it is hurting china as well • Economist believe that China reserves will not grow exponential as they need to invest on infrastructure, health and education of poor. • US budget deficit could be reduced by generating greater domestic savings
References
• http://www.aasc.ucla.edu/uschina/trade_curr ency.shtml
Thank You
doc_394508309.pptx