Treasuries, what can you hold? Therefore, countries with similar characteristics accumulate reserves to avoid negative assessment by the financial market, especially when compared to members of a peer group. The traditional one is the spread between government debt and the yield on reserves. Contact us Already a Member? Since the amount of foreign reserves available to defend a weak currency a currency in low demand is limited, a currency crisis or devaluation could be the end result.
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A rule usually followed by central banks is to hold the equivalency of at least three months of imports in foreign currency. Also, an increase in reserves occurred when commercial openness increased part of the process known as globalization.
Reserve accumulation was faster than that which would be explained by trade, since the ratio has increased to several months of imports. Furthermore, the external trade factor explains why the ratio of reserves in months of imports is closely watched by credit risk agencies. The opening of a financial account of the balance of payments has been important during the last decade. Hence, financial flows such as direct investment and portfolio investment became more important.
Usually financial flows are more volatile that enforce the necessity of higher reserves. Moreover, holding reserves, as a consequence of the increasing of financial flows, is known as Guidotti—Greenspan rule that states a country should hold liquid reserves equal to their foreign liabilities coming due within a year. Reserve accumulation can be an instrument to interfere with the exchange rate. Hence, commercial distortions such as subsidies and taxes are strongly discouraged.
However, there is no global framework to regulate financial flows. As an example of regional framework, members of the European Union are prohibited from introducing capital controls , except in an extraordinary situation.
Some economists are trying to explain this behavior. Usually, the explanation is based on a sophisticated variation of mercantilism , such as to protect the take-off in the tradable sector of an economy, by avoiding the real exchange rate appreciation that would naturally arise from this process. One attempt  uses a standard model of open economy intertemporal consumption to show that it is possible to replicate a tariff on imports or a subsidy on exports by closing the current account and accumulating reserves.
Another  is more related to the economic growth literature. The argument is that the tradable sector of an economy is more capital intense than the non-tradable sector. The private sector invests too little in capital, since it fails to understand the social gains of a higher capital ratio given by externalities like improvements in human capital, higher competition, technological spillovers and increasing returns to scale.
The government could improve the equilibrium by imposing subsidies and tariffs , but the hypothesis is that the government is unable to distinguish between good investment opportunities and rent seeking schemes. Thus, reserves accumulation would correspond to a loan to foreigners to purchase a quantity of tradable goods from the economy. In this case, the real exchange rate would depreciate and the growth rate would increase.
In some cases, this could improve welfare, since the higher growth rate would compensate the loss of the tradable goods that could be consumed or invested. In this context, foreigners have the role to choose only the useful tradable goods sectors.
Reserve accumulation can be seen as a way of "forced savings". The government, by closing the financial account, would force the private sector to buy domestic debt in the lack of better alternatives. With these resources, the government buys foreign assets. Thus, the government coordinates the savings accumulation in the form of reserves.
Sovereign wealth funds are examples of governments that try to save the windfall of booming exports as long-term assets to be used when the source of the windfall is extinguished. There are costs in maintaining large currency reserves. Price 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. Several calculations have been attempted to measure the cost of reserves. The traditional one is the spread between government debt and the yield on reserves. The caveat is that higher reserves can decrease the perception of risk and thus the government bond interest rate, so this measures can overstate the cost. Alternatively, another measure compares the yield in reserves with the alternative scenario of the resources being invested in capital stock to the economy, which is hard to measure.
One interesting  measure tries to compare the spread between short term foreign borrowing of the private sector and yields on reserves, recognizing that reserves can correspond to a transfer between the private and the public sectors. In the context of theoretical economic models it is possible to simulate economies with different policies accumulate reserves or not and directly compare the welfare in terms of consumption.
Results are mixed, since they depend on specific features of the models. A case to point out is that of the Swiss National Bank , the central bank of Switzerland. The Swiss franc is regarded as a safe haven currency , so it usually appreciates during market's stress. In the aftermath of the crisis and during the initial stages of the Eurozone crisis , the Swiss franc CHF appreciated sharply.
The central bank resisted appreciation by buying reserves. After accumulating reserves during 15 months until June , the SNB let the currency appreciate. The modern exchange market as tied to the prices of gold began during 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 —, the US dollar was convertible into gold through the Federal Reserve System, but after only central banks could convert dollars into gold from official gold reserves, and after no individual or institution could convert US dollars into gold from official gold reserves. Since , 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. Central banks throughout the world have sometimes cooperated in buying and selling official international reserves to attempt to influence exchange rates and avert financial crisis.
Historically, especially before the Asian financial crisis , central banks had rather meager reserves by today's standards and were therefore subject to the whims of the market, of which there was accusations of hot money manipulation, however Japan was the exception. In the case of Japan, forex reserves began their ascent a decade earlier, shortly after the Plaza Accord in , and were primarily used as a tool to weaken the surging yen.
This build-up has major implications for today's developed world economy, by setting aside so much cash that was piled into US and European debt, investment had been crowded out , the developed world economy had effectively slowed to a crawl, giving birth to contemporary negative interest rates.
By , the world had experienced yet another financial crisis, this time the US Federal Reserve organized Central bank liquidity swaps with other institutions. Developed countries authorities adopted extra expansionary monetary and fiscal policies, which led to the appreciation of currencies of some emerging markets.
The resistance to appreciation and the fear of lost competitiveness led to policies aiming to prevent inflows of capital and more accumulation of reserves.
This pattern was called currency war by an exasperated Brazilian authority, and again in followed the commodities collapse , Mexico had warned China of triggering currency wars. The IMF proposed a new metric to assess reserves adequacy in Those liquidity needs are calculated taking in consideration the correlation between various components of the balance of payments and the probability of tail events.
The higher the ratio of reserves to the developed metric, the lower is the risk of a crisis and the drop in consumption during a crisis. Besides that, the Fund does econometric analysis of several factors listed above and finds those reserves ratios are generally adequate among emerging markets.
Reserves that are above the adequacy ratio can be used in other government funds invested in more risky assets such as sovereign wealth funds or as insurance to time of crisis, such as stabilization funds.
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List of countries by foreign-exchange reserves excluding gold. Retrieved 12 July Archived from the original on 8 October Retrieved 11 June Balance of payments manual. Archived PDF from the original on 11 April Retrieved 16 March Archived PDF from the original on 10 October Archived from the original on 29 May As the threat is not credible and the effect would be limited even if carried out, it does not offer China deterrence options, whether in the diplomatic, military, or economic realms, and this would remain true both in peacetime and in scenarios of crisis or war.
Treasury securities represent only a small part of total U. A significant number of economists and analysts dismiss any and all concerns over foreign holdings of United States government debt denominated in U. Dollars , including China's holdings. From Wikipedia, the free encyclopedia. Redirected from Foreign exchange reserves of China. Treasuries, what can you hold? Treasuries are the safe haven.
For everyone, including China, it is the only option. Debt A National Security Threat? Should Americans be concerned that China has started dumping some of its Treasury holdings? After all, it raises serious questions about whether China will keep lending Washington money to help finance the federal deficit in the future.
From "China is dumping U. Implications for the U. Economy" by Wayne M. What about indebtedness to foreigners? That is a cost to China. For China, the bonds themselves are a sterile hoard.
There is almost nothing that Beijing can do with them; And we will pay interest on it, not with real effort but by typing numbers into computers. There is no burden associated with this; not now and not later. The Chinese buy U. T-securities by transferring U.