Description
Documentation about whether it is good for a country to keep the foreign exchange reserves.
Macroeconomics project
Submitted to Prof Devi Prasad bedari
Submitted by [Group L1] Abhishek Vyas Anubhav Tripathi Arpita Verma Girish Shetty Vamsi Krishna
Table of Contents
Abstract ................................................................................................................. 3 Introduction ........................................................................................................... 3 Reasons for Accumulation of ForEx Reserves......................................................... 4 Cost of holding forex reserves................................................................................ 6 Chinese forex ......................................................................................................... 6 Advantages to China .............................................................................................. 8 Impact of China’s foreign exchange reserves on America ...................................... 9 Chinese dumping of Dollars ................................................................................... 9 The road ahead .................................................................................................... 10 Summary/ Conclusion .......................................................................................... 11 References ........................................................................................................... 11
Abstract
The paper investigates whether it is good for a country to keep the foreign exchange reserves. This study shows how large foreign exchange reserves helped developing and NIEs (newly industrialized economies) to sustain during financial crisis. Also the paper describes how excessive foreign exchange reserves can be detrimental to the world economy and to the country itself. We have taken china as an example for this purpose.
Introduction
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. 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
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 them 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 Prior to the era of financial globalization, countries held reserves mainly to manage foreign exchange demand and supply arising from current account transactions. The traditional rule of thumb for Central Banks was that they should hold a quantity of foreign exchange reserves equivalent to three months of imports. Therefore, at least part of the increase in reserves may be due to the increased commercial openness of developing countries, and increased commercial openness of developing countries.
In short the developing nations want to hold liquid reserves equal to their foreign liabilities which mean short-term debt/reserves ratios is unity. The only exception in 2004 was Argentina, a country that was just coming out of a severe financial crash.
Next, we tried to look into is it only the developing or the emerging nations that is in the race of building up forex reserves. We found that not only the Asian countries but the poor African countries are also building their forex reserves so that they can sustain during difficult times. The traditional rule of thumb for Central Banks was that they should hold a quantity of foreign exchange reserves equivalent to three months of imports. The figure shows a geographical breakdown of reserve trends. The surprise here is that the increase in reserves has not been restricted to “emerging markets.” In fact, the increase in Africa’s reserves is as striking as that of Asia. By 2004, Africa held reserves worth around 8 months of imports, compared to 6 months in the Western hemisphere and close to 10 months in Asia. So the reserve buildup is a phenomenon that affects the world’s poorest countries as well.
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.
Chinese forex
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. The data speaks the story in 1994, China had less than $25 billion of foreign currency reserves. Since then, China’s enormous trade surplus and the inflow of foreign investment have helped boost its foreign exchange reserves to U.S. $1.76 trillion by the end of April 2008 with reserves said to be growing by U.S. $100 million per hour. Whereas many economists tend to think that a country’s foreign reserves should be sufficient to pay for 3-6 months of imports, China’s reserves can pay for a year and half of imports – leading many to conclude that China’s foreign reserves are unnecessarily large so we looked into how it will affect the world’s economy.
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.
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. 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
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
As the country with the largest foreign exchange reserves, China attracted great attention on the issue of funding the IMF (International Monetary Fund). It was prepared to provide $100 billion to IMF, to help those countries badly hurt in the global financial crisis. It wanted to play a leading role in regional cooperation in Asia; in the establishment of a stable international economic system to strengthen financial cooperation and the independent development of Asia. China’s gesture also brought about Japanese investment in the IMF.
Since the United States and Japan are allies and Japan is ranked second among the IMF's shareholders, with its $3 trillion of non-government foreign exchange reserves and huge official foreign exchange reserves, it is certain that Japan will inject funds, both from its political interests and the actual situation.
A country with high foreign exchange reserves such as China can be interested in the following aspects: 1. International Development Association (IDA) support for low-income countries. IDA-15 negotiation raised a fund of $42 billion, which was used in the next three years 2. International Bank for Reconstruction and Development (IBRD) providing loans to middle-income countries. Last year’s budget was $ 13.5 billion, and this year it can provide $27 billion 3. International Finance Corporation (IFC) strengthening capital structure of central banks in developing countries to invest in private enterprises. If central bank capital is short, IFC will provide funds to those countries as a strategic investment partner. It can help tide over a crisis so as to prevent meltdown and economic recession. When a financial crisis or payment crisis emerges in a developing country, China could provide funds to assist the offset of difficulties brought about by the absence of private capital flows.
China believes that with strong foreign exchange reserves and regional coordination, the 1997 type of financial crisis will not recur. There is a direct competitive relation among East Asia's collective system of foreign exchange reserves and the World Bank and International Monetary Fund. Some economists have called for the establishment of a mechanism in East Asia independent of IMF. Under such a system, China and Japan's cooperation and competition must be very subtle.
Advantages to China
For many years, SAFE has parked about 70% of its reserves in government-backed securities – primarily U.S. Treasury bills – with the rest in Euros and Japanese Yen. In the last several years, though, as the dollar has declined in value relative to the yuan, the Chinese government has indicated a desire to diversify its investments in order to get a better return. In recent years, however, with a host of other domestic problems besetting the country, the Chinese people are starting to question why their government is financing another country’s spending spree instead of using some of the large reserves to address the country’s domestic needs.
Impact of China’s foreign exchange reserves on America
The United States has welcomed China’s investment of its excess foreign reserves in U.S. Treasury bills, which 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 (including those of politicians criticizing China), to rebuilding roads in New Orleans, and writing Social Security and Medicare checks. In turn, China has had a safe place to park its excess dollars. Although both the United States and China have benefited from this arrangement, many experts and observers believe this is not a tenable situation in the long run. According to economists at the Petersen Institute of International Economics, in early 2008, 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. After all, at some point, foreign appetite for dollar assets will wane. As average Americans become more aware of the reality that they are relying on money controlled by a foreign government and that never in America’s history has she been so deeply in debt to another country (as of early 2008, foreigners now control over 40% of the U.S. national debt), especially one with whom America shares an ambivalent relationship, and who America has at times blamed for taking away job, fear is setting in about how long this imbalance will continue and about what might happen should China decide to pull its massive reserves out of the U.S. economy. Moreover, long-term U.S. interest rates are driven by the buying and selling of bonds, making these interest rates effectively at the control of foreign central banks, especially those of China and Japan. In short, China’s excessive foreign exchange reserves are causing some Americans to fear that control of their economy is increasingly at the mercy of China.
Chinese dumping of Dollars
Moving from dollar assets to other assets will cause the dollar to depreciate, as the dollar will be worth less. At the same time, the bulk sale of U.S. treasury bills (short term bonds) could cause U.S. bond prices to drop and therefore yields to increase. Since government bond yields determine mortgage rates, this will result in higher long-term interest rates, which could make
borrowing for a home more difficult, which would in turn further decrease already-dampened demand for housing and cause even more of a decline in the value of American real estate. While China has in fact been looking to diversify its forex reserves by investing abroad, it will likely do so very gradually and in relatively small amounts, for otherwise they would stand to lose a lot with a bulk sale of U.S. treasuries as the value of the government bonds they don’t sell would decline. Hence, any moves toward diversification should have minimal impact on the value of the dollar. And although the value of the dollar is weak, there is no more stable alternative right now for China’s vast sums. Most economists agree that barring any unforeseen or major incident between the two countries, China will not exercise this economic “nuclear option” as China already has its own set of domestic problems to contend with at home as a result of its enormous forex reserves.
The road ahead
China: The yuan’s slow appreciation does not seem to have had much of an impact in reducing China’s reserves; hence some economists believe China will have to allow for an even faster appreciation, though that may hurt exporters. China will also likely face higher inflation, which the government may try to offset by using some of the reserves to give subsidies to the poor, though it has to be careful not to exacerbate inflation in the process. Some experts think China’s foreign exchange reserves will not continue to grow “exponentially” as some have feared because there is pressure to use some of it on China’s infrastructure needs and on education and health for the poor.
United States: Many economists, such as those at the Petersen Institute of International Economics, think that correcting the U.S.’ global current account deficit is the highest priority for U.S. foreign economic policy. Proposals for the useful short-term remedy include sizably reducing the U.S. budget deficit; generating greater domestic savings than greater output, thus expanding U.S. net exports; expanding domestic demand in other major economies such as China, Japan, and Europe to absorb U.S. exports; and the continuing gradual realignment of exchange rates. While the U.S. can continue to pressure foreign economies to shoulder more responsibility for global consumption (China has a savings rate of about 50%), these autonomous sovereign nations in the end will act in their own self-interest. The only part that the U.S. has any real control over is in regards to its own spending habits. Unfortunately, the likelihood of the U.S. reducing its budget deficit in lean times and during an election year is not very high. Expect American politicians unwilling to get their own house in order (undoubtedly at some cost to the American public) to continue to put the blame and responsibility on foreign countries and to threaten protectionist responses.
Summary/ Conclusion
Hence, it is preferable to build up reserves by running current account surpluses, which in turn requires a competitive exchange rate. Maintaining a competitive exchange rate requires policy and structural reforms but it is rendered difficult, if not impossible, when there are large inflows of capital. Such inflows may have long-run benefits, but from a self-insurance perspective, they serve two purposes: they increase the vulnerability to crises but also make self-insurance against crises more difficult because competitive exchange rates are less easy to maintain. Self-insurance therefore requires a mercantilist slant to exchange rate policy and caution about capital account opening.
References
http://www.aasc.ucla.edu/uschina/trade_currency.shtml http://www.voxeu.org/index.php?q=node/182 http://en.wikipedia.org/wiki/Foreign_exchange_reserves www.rbi.org.in
doc_337244700.docx
Documentation about whether it is good for a country to keep the foreign exchange reserves.
Macroeconomics project
Submitted to Prof Devi Prasad bedari
Submitted by [Group L1] Abhishek Vyas Anubhav Tripathi Arpita Verma Girish Shetty Vamsi Krishna
Table of Contents
Abstract ................................................................................................................. 3 Introduction ........................................................................................................... 3 Reasons for Accumulation of ForEx Reserves......................................................... 4 Cost of holding forex reserves................................................................................ 6 Chinese forex ......................................................................................................... 6 Advantages to China .............................................................................................. 8 Impact of China’s foreign exchange reserves on America ...................................... 9 Chinese dumping of Dollars ................................................................................... 9 The road ahead .................................................................................................... 10 Summary/ Conclusion .......................................................................................... 11 References ........................................................................................................... 11
Abstract
The paper investigates whether it is good for a country to keep the foreign exchange reserves. This study shows how large foreign exchange reserves helped developing and NIEs (newly industrialized economies) to sustain during financial crisis. Also the paper describes how excessive foreign exchange reserves can be detrimental to the world economy and to the country itself. We have taken china as an example for this purpose.
Introduction
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. 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
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 them 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 Prior to the era of financial globalization, countries held reserves mainly to manage foreign exchange demand and supply arising from current account transactions. The traditional rule of thumb for Central Banks was that they should hold a quantity of foreign exchange reserves equivalent to three months of imports. Therefore, at least part of the increase in reserves may be due to the increased commercial openness of developing countries, and increased commercial openness of developing countries.
In short the developing nations want to hold liquid reserves equal to their foreign liabilities which mean short-term debt/reserves ratios is unity. The only exception in 2004 was Argentina, a country that was just coming out of a severe financial crash.
Next, we tried to look into is it only the developing or the emerging nations that is in the race of building up forex reserves. We found that not only the Asian countries but the poor African countries are also building their forex reserves so that they can sustain during difficult times. The traditional rule of thumb for Central Banks was that they should hold a quantity of foreign exchange reserves equivalent to three months of imports. The figure shows a geographical breakdown of reserve trends. The surprise here is that the increase in reserves has not been restricted to “emerging markets.” In fact, the increase in Africa’s reserves is as striking as that of Asia. By 2004, Africa held reserves worth around 8 months of imports, compared to 6 months in the Western hemisphere and close to 10 months in Asia. So the reserve buildup is a phenomenon that affects the world’s poorest countries as well.
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.
Chinese forex
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. The data speaks the story in 1994, China had less than $25 billion of foreign currency reserves. Since then, China’s enormous trade surplus and the inflow of foreign investment have helped boost its foreign exchange reserves to U.S. $1.76 trillion by the end of April 2008 with reserves said to be growing by U.S. $100 million per hour. Whereas many economists tend to think that a country’s foreign reserves should be sufficient to pay for 3-6 months of imports, China’s reserves can pay for a year and half of imports – leading many to conclude that China’s foreign reserves are unnecessarily large so we looked into how it will affect the world’s economy.
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.
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. 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
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
As the country with the largest foreign exchange reserves, China attracted great attention on the issue of funding the IMF (International Monetary Fund). It was prepared to provide $100 billion to IMF, to help those countries badly hurt in the global financial crisis. It wanted to play a leading role in regional cooperation in Asia; in the establishment of a stable international economic system to strengthen financial cooperation and the independent development of Asia. China’s gesture also brought about Japanese investment in the IMF.
Since the United States and Japan are allies and Japan is ranked second among the IMF's shareholders, with its $3 trillion of non-government foreign exchange reserves and huge official foreign exchange reserves, it is certain that Japan will inject funds, both from its political interests and the actual situation.
A country with high foreign exchange reserves such as China can be interested in the following aspects: 1. International Development Association (IDA) support for low-income countries. IDA-15 negotiation raised a fund of $42 billion, which was used in the next three years 2. International Bank for Reconstruction and Development (IBRD) providing loans to middle-income countries. Last year’s budget was $ 13.5 billion, and this year it can provide $27 billion 3. International Finance Corporation (IFC) strengthening capital structure of central banks in developing countries to invest in private enterprises. If central bank capital is short, IFC will provide funds to those countries as a strategic investment partner. It can help tide over a crisis so as to prevent meltdown and economic recession. When a financial crisis or payment crisis emerges in a developing country, China could provide funds to assist the offset of difficulties brought about by the absence of private capital flows.
China believes that with strong foreign exchange reserves and regional coordination, the 1997 type of financial crisis will not recur. There is a direct competitive relation among East Asia's collective system of foreign exchange reserves and the World Bank and International Monetary Fund. Some economists have called for the establishment of a mechanism in East Asia independent of IMF. Under such a system, China and Japan's cooperation and competition must be very subtle.
Advantages to China
For many years, SAFE has parked about 70% of its reserves in government-backed securities – primarily U.S. Treasury bills – with the rest in Euros and Japanese Yen. In the last several years, though, as the dollar has declined in value relative to the yuan, the Chinese government has indicated a desire to diversify its investments in order to get a better return. In recent years, however, with a host of other domestic problems besetting the country, the Chinese people are starting to question why their government is financing another country’s spending spree instead of using some of the large reserves to address the country’s domestic needs.
Impact of China’s foreign exchange reserves on America
The United States has welcomed China’s investment of its excess foreign reserves in U.S. Treasury bills, which 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 (including those of politicians criticizing China), to rebuilding roads in New Orleans, and writing Social Security and Medicare checks. In turn, China has had a safe place to park its excess dollars. Although both the United States and China have benefited from this arrangement, many experts and observers believe this is not a tenable situation in the long run. According to economists at the Petersen Institute of International Economics, in early 2008, 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. After all, at some point, foreign appetite for dollar assets will wane. As average Americans become more aware of the reality that they are relying on money controlled by a foreign government and that never in America’s history has she been so deeply in debt to another country (as of early 2008, foreigners now control over 40% of the U.S. national debt), especially one with whom America shares an ambivalent relationship, and who America has at times blamed for taking away job, fear is setting in about how long this imbalance will continue and about what might happen should China decide to pull its massive reserves out of the U.S. economy. Moreover, long-term U.S. interest rates are driven by the buying and selling of bonds, making these interest rates effectively at the control of foreign central banks, especially those of China and Japan. In short, China’s excessive foreign exchange reserves are causing some Americans to fear that control of their economy is increasingly at the mercy of China.
Chinese dumping of Dollars
Moving from dollar assets to other assets will cause the dollar to depreciate, as the dollar will be worth less. At the same time, the bulk sale of U.S. treasury bills (short term bonds) could cause U.S. bond prices to drop and therefore yields to increase. Since government bond yields determine mortgage rates, this will result in higher long-term interest rates, which could make
borrowing for a home more difficult, which would in turn further decrease already-dampened demand for housing and cause even more of a decline in the value of American real estate. While China has in fact been looking to diversify its forex reserves by investing abroad, it will likely do so very gradually and in relatively small amounts, for otherwise they would stand to lose a lot with a bulk sale of U.S. treasuries as the value of the government bonds they don’t sell would decline. Hence, any moves toward diversification should have minimal impact on the value of the dollar. And although the value of the dollar is weak, there is no more stable alternative right now for China’s vast sums. Most economists agree that barring any unforeseen or major incident between the two countries, China will not exercise this economic “nuclear option” as China already has its own set of domestic problems to contend with at home as a result of its enormous forex reserves.
The road ahead
China: The yuan’s slow appreciation does not seem to have had much of an impact in reducing China’s reserves; hence some economists believe China will have to allow for an even faster appreciation, though that may hurt exporters. China will also likely face higher inflation, which the government may try to offset by using some of the reserves to give subsidies to the poor, though it has to be careful not to exacerbate inflation in the process. Some experts think China’s foreign exchange reserves will not continue to grow “exponentially” as some have feared because there is pressure to use some of it on China’s infrastructure needs and on education and health for the poor.
United States: Many economists, such as those at the Petersen Institute of International Economics, think that correcting the U.S.’ global current account deficit is the highest priority for U.S. foreign economic policy. Proposals for the useful short-term remedy include sizably reducing the U.S. budget deficit; generating greater domestic savings than greater output, thus expanding U.S. net exports; expanding domestic demand in other major economies such as China, Japan, and Europe to absorb U.S. exports; and the continuing gradual realignment of exchange rates. While the U.S. can continue to pressure foreign economies to shoulder more responsibility for global consumption (China has a savings rate of about 50%), these autonomous sovereign nations in the end will act in their own self-interest. The only part that the U.S. has any real control over is in regards to its own spending habits. Unfortunately, the likelihood of the U.S. reducing its budget deficit in lean times and during an election year is not very high. Expect American politicians unwilling to get their own house in order (undoubtedly at some cost to the American public) to continue to put the blame and responsibility on foreign countries and to threaten protectionist responses.
Summary/ Conclusion
Hence, it is preferable to build up reserves by running current account surpluses, which in turn requires a competitive exchange rate. Maintaining a competitive exchange rate requires policy and structural reforms but it is rendered difficult, if not impossible, when there are large inflows of capital. Such inflows may have long-run benefits, but from a self-insurance perspective, they serve two purposes: they increase the vulnerability to crises but also make self-insurance against crises more difficult because competitive exchange rates are less easy to maintain. Self-insurance therefore requires a mercantilist slant to exchange rate policy and caution about capital account opening.
References
http://www.aasc.ucla.edu/uschina/trade_currency.shtml http://www.voxeu.org/index.php?q=node/182 http://en.wikipedia.org/wiki/Foreign_exchange_reserves www.rbi.org.in
doc_337244700.docx